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Tax Policy and Controversy BriefingA quarterly review of global tax policy and controversy developments

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1Welcome

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Tax Policy and Controversy Briefing is published each quarter by Ernst & Young. Editor Rob Thomas [email protected] | +44 207 980 0814

To access previous issues and to learn more about Ernst & Young’s Tax Policy and Controversy global network, please go to www.ey.com/tpc.

Connect with Ernst & Young Tax in the following ways: www.ey.com/tax www.ernstyoung.mobi for mobile devices www.twitter.com/eytax for breaking tax news

Issue 3 | February 2010

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1 2 3 4Welcome Special focus: China strengthens tax collection on non-residents’ equity sales

Special focus: French Parliament enacts Finance Bill for 2010 and Amended Finance Bill for 2009

“I think moving forward, joint and simultaneous tax audits will happen very quickly.”

Dave Hartnett, HMRC See page 12

45 4843 Country round-up

35The spotlight is tightly focused on the financial services sector. Will 2010 see a global levy implemented?

Financial Transaction Levy — will 2010 be the year?

22Vice President, Finance & Accounting, Global Taxes — Procter & Gamble

An interview with Tim McDonald

17Navigating the changing global tax controversy and risk management landscape

Tax administration without borders

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Implications reach beyond tax and into the boardroom for companies around the world

US proposes requirement to disclose uncertain tax positions on tax return

11Dave Hartnett, Permanent Secretary for Tax at Her Majesty’s Revenue and Customs shares his insights

An interview with Dave Hartnett 32

The continuing convergence between emerging and developed economies

The new contributors to world economic growth

26We discuss how Copenhagen brings increased tax complexity

Implications of the Copenhagen accord for CFOs and tax directors

41Rate changes, harmonization and reform — it’s all happening in the indirect tax arena

Indirect Tax in 2010

We are very pleased to offer you a warm welcome to the third issue of our Tax Policy and Controversy Quarterly Briefing. The world of tax has seen some very significant developments in the last quarter, extending some of the trends we talked about in our last issue. This continues to be a challenging time to be a tax director.

One of the key themes we identified in our last issue1 was the increasing pace of globalization and increasing tax competition between countries, as evidenced by the increasing breadth of countries that Fortune 500 companies now call their headquarters home. In this last quarter we have seen tax authorities in different jurisdictions continue to focus strongly on globalization, taking a look both up and down corporate structures:

• Looking down corporate structures, we have seen fundamental reviews of CFC regimes in both Australia and the United Kingdom, which are aimed at updating these rules for a territorial focus, allowing groups headquartered in those locations to compete more effectively in an increasingly global environment.

• We have also seen an increased focus up corporate structures with investee countries continuing to train their spotlight upon indirect disposals of companies in their jurisdiction. China’s recent Circular 698 echoes the policies evidenced recently in Peru and India meaning that investors now need to take a far greater focus on their exit strategy when investing. You can read more about the Chinese measures on page 52. In Western Europe, France has reinforced its real property tax by explicitly setting out that the sale of shares in companies considered to be real estate companies falls within the scope of the French 5% real estate transfer tax, irrespective of the tax residency of such companies.

Another trend highlighted in our last edition was the increasing shift towards consumption taxes2 and, as shown in our article Indirect tax in 2010 on page 48, this shift is certainly set to continue, with VAT, GST, customs and excise tax rises coming into force or announced in many countries. This reinforces the need for the tax function to focus closely on those taxes that appear above the line, as these are increasingly taking up a large proportion of the corporate tax burden.

Welcome

2010: Globalization back on the agendaGovernments, regulators, tax administrators and multinationals all get back to the business of globalization.

Bob Brown Global Director, Tax Controversy Services Tel: +44 (0) 207 951 4724 Email: [email protected]

Chris Sanger Global Director, Tax Policy Services Tel: +44 (0) 207 951 0150 Email: [email protected]

Late-breaking newsIRS developing new schedule for use by business taxpayers to disclose uncertain tax positions

The IRS has announced it is developing a new schedule intended for use by business taxpayers with assets over $10 million to report uncertain tax positions on their tax returns. The schedule will require a concise description of each uncertain tax position and the maximum amount of potential federal tax liability attributable to those positions (determined without regard to the taxpayer’s risk analysis of its likelihood of prevailing on the merits). Taxpayers will not be required to disclose their risk assessment or tax reserve amounts; however, the IRS notes that it can compel production of that information via summons. The new measure will be applicable to non-US headquartered businesses with US subsidiaries.

Reforming the UK CFC regime

HMRC and Her Majesty’s Treasury have issued a discussion document on reforming the UK’s CFC regime. The consultation period runs until 20 April 2010.

Obama Administration releases FY 2011 tax proposals

The Obama Administration’s proposed budget for FY 2011 contains a number of proposals from last year, as well as some significant new revenue provisions. Like last year’s budget, the new budget released 1 February would make permanent the research credit, repeal LIFO, codify the economic substance doctrine, tax carried interest as ordinary income and repeal a host of tax preferences for oil and gas companies. New in this year’s budget are proposals to impose a “financial crisis responsibility fee” on large financial institutions, restrict multinationals’ ability to transfer Intellectual Property (IP) to offshore subsidiaries, modify the worker classification rules under Section 530 of the Revenue Act of 1978 and create $5 billion worth of additional clean energy incentives under Section 48C. The budget does not include a proposal from last year to curtail use of the “check the box” rules. Also, the budget would allow the 2001 Bush tax cuts to expire for taxpayers with annual incomes exceeding $250,000 (married) or $200,000 (single).

1 www.ey.com/tpcbriefing 2 From income to consumption — the shifting tax balance: November 2009. See www.ey.com/tpcbriefing

Tax Policy and Controversy Briefing 4

Globalization brings its own challenges, however, and some efforts to design and implement global approaches on certain key issues have found it difficult to move ahead. This briefing features an article on environmental taxes and the Copenhagen summit, where the absence of a global agreement has increased the risk that many countries will introduce their own, different tax regimes, missing a potential opportunity to produce a global tax framework for climate change.

This is echoed in the financial services sector. While the agreement to design a global Financial Transaction Levy (FTL) remains an undecided and controversial issue, we have seen countries announce national measures to address local market needs, leading to further complications, complexity and risks of double taxation and discrepancies.

Since the last issue of this publication, we have launched a global study, Tax administration without borders3, which looks at globalization through the lens of tax administration and tax enforcement. The study, released in November 2009, predicted a much higher level of interaction between tax administrations

and predicted that innovations made by a tax administration in one jurisdiction will be even more rapidly replicated by other countries. Such innovations include Alternative Dispute Resolution, which is commented on by Tim McDonald of Procter & Gamble in his interview with us.

Indeed, Dave Hartnett of HMRC endorses that possibility in his recent interview with Ernst & Young that you can read on page 12. This increasing interconnection between tax administrations will be more and more visible in 2010 and it will be fascinating to see how other governments — particularly those who form a part of the JITSIC organization — will react to the recent news that the IRS has proposed a significant increase in taxpayer disclosure of uncertain tax positions.

It has been a very busy quarter, to say the least, and it looks like this trend is set to continue through 2010. The rapidly changing environment is driving changes to tax policy, legislation and regulation at a pace that can be challenging to follow. We hope that our Tax Policy and Controversy Quarterly Briefing will give you some increased insight in that regard.

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Chris Sanger Global Director, Tax Policy Services

Tel: +44 (0) 207 951 0150

Email: [email protected]

Bob Brown Global Director, Tax Controversy Services

Tel: +44 (0) 207 951 4724


Mexican tax reform approved by congress.

China strengthens tax collection on non-residents’ equity sales in Circular 698.

Hong Kong issues its first set of transfer pricing guidelines.

Japan sets out tax reform proposals.

Brazil launches tax on financial transactions.

Canada: A Harmonized Sales Tax (HST) is planned for 1 July 2010, when the provinces of Ontario and British Columbia replace their existing Provincial sales tax systems and harmonize them with the federal GST.

Russia releases new draft transfer pricing law.

Netherlands withdraws earlier proposals reforming taxation of interest income and expenses; considers move to full territorial system for foreign branch income.

Belgian Council of Ministers set the maximum Notional Interest Deduction (NID) percentage at 3.80%.

Czech Republic: The standard VAT rate increased to 20% on 1 January 2010.

Finland: The standard rate of VAT will increase to 23% on 1 July 2010.

UK bank bonus tax unveiled.

UK: CFC discussion document released and discussion period opened.

Spanish corporate income tax rate increases from 18% to 19% effective 1 January 2010. VAT rate to rise from 16% to 18% effective 1 July 2010.

France bank bonus tax unveiled.

French Parliament enacts Finance Bill for 2010 and amended Finance Bill for 2009.

Ireland announces 12.5% corporate tax rate “is here to stay” in austerity budget.

United States: Obama Administration releases FY 2011 tax proposals.

United States: IRS proposes required taxpayer disclosure of uncertain tax positions.

United States Healthcare reform: House and Senate pass versions.

African Tax Administration Forum launched.

India releases GST discussion paper.

Australia: Consultation paper on CFC reform released with submissions closing 1 March 2010.

3 www.ey.com/taxadministrationwithoutborders


During a 26 January 2010 speech1 before the New York State Bar Association Taxation Section, United States Internal Revenue Commissioner Douglas Shulman announced a proposal that would extend the disclosure of uncertain tax positions beyond the financial statement and onto the federal tax return.

Commissioner Shulman positioned the proposal as part of an ongoing Internal Revenue Service (IRS) effort to “improve transparency regarding material tax issues” in pursuit of greater “certainty, consistency, and efficiency,” stating that the proposed new requirement would “cut down the time it takes to find issues and complete an audit … ensure that both the IRS and taxpayer spend time discussing the law as it applies to their facts, rather than looking for information … and help prioritize selection of issues and taxpayers for examination.”

We sat down with Rob Hanson, EY’s Tax Controversy and Risk Management Services Leader in the Americas to try to better understand the potential scope, implications and impact of the proposed new requirement.

Tax policy and controversy briefing (TPCB) Hi Rob, as a starting point, would you be able to give us a few highlights about what exactly the IRS is proposing?

Rob Hanson Sure. Let’s start with what we know about this new proposal because there is much that we won’t know until the final reporting and disclosure rules are issued. For example, we know that the essential focus of the proposal, as it stands currently, is quite clear: business taxpayers would be required to disclose uncertain tax

positions (UTPs) that have been identified for financial statement purposes on a new form or schedule that will be included as part of their annual tax return filings. Not all business taxpayers would be subject to the new rules, however; only certain business taxpayers with assets over US$10 million are proposed to be covered.

In addition, IRS describes these potential new reporting and disclosure requirements as requiring a “concise description” of each UTP — a few sentences that apprise IRS of the nature of the issue — along with an estimate of the maximum amount of potential federal tax liability if the position were to be disallowed in its entirety during IRS audit. More of the operational details, as they are currently proposed, can be found in Announcement 2010-92, “Uncertain Tax Positions — Policy of Restraint,” which the IRS released on 26 January, but I think that I have described the core elements of the proposal.

TPCB This sounds similar to what companies are already being required to report for financial statement purposes under US Financial Accounting Standard Board’s Interpretation No. (FIN) 48, Accounting for Uncertainity in Income Taxes. Will companies be able to take their calculations for FIN 48 and just apply these to the tax return?

Rob Hanson You’re right, a basic premise of this proposed tax reporting requirement is that taxpayers are already required by FIN 48 (and other accounting standards) to identify and quantify UTPs. From what we’ve seen thus far in the Announcement, however, it does not seem likely that companies will be able to simply transfer their FIN 48 calculations to their tax return.

Rob Hanson, Tax Controversy and Risk Management Services Leader — Americas

Tel: +1 202 327 5696 Email: [email protected]

US proposes requirement to disclose uncertain tax positions on tax returnImplications reach beyond tax and into the boardroom for companies around the world

“The essential focus of the proposal is quite clear — business taxpayers would be required to disclose uncertain tax positions (UTPs) that have been identified for financial statement purposes on a new form or schedule that will be included as part of their annual tax return filings.”

“It does not seem likely that companies will be able to simply transfer their FIN 48 calculations to their tax return.”

1 http://www.irs.gov/newsroom/article/0,,id=218705,00.html 2 http://www.irs.gov/pub/irs-drop/a-10-09.pdf


Additional analysis will almost certainly need to be performed for the tax return, and I would expect a number of the public comments to be focused on the additional work that taxpayers will need to undertake.

For example, the “maximum exposure” would need to be calculated for tax reporting purposes. In the absence of clear guidelines, this might prove to be fairly difficult in some circumstances. Plus, some positions for which no reserve was established, either because the taxpayer intends to litigate the position or has determined that the IRS has an administrative practice not to challenge the position, would be required to be reported on the disclosure schedule. Companies also forego financial statement disclosure of tax reserves that are immaterial to the financials and will need to look carefully at the final rules to determine how those will need to be disclosed in a tax return. So, while the effect is similar — greater transparency regarding uncertain tax positions — the nature of the information that would be required by this proposed new requirement is different enough to require additional processes.

Requirements under IFRS and other accounting standards

TPCB Are these new reporting requirements tied solely to FIN 48 or would taxpayers subject to other accounting standards, such as IFRS, potentially be subject to these same reporting requirements?

Rob Hanson Well, that’s an interesting question. The Announcement suggests that it won’t matter whether financial statements are prepared under FIN 48 or other similar accounting standards, including International Financial Reporting Standards (IFRS). The IRS Commissioner made similar comments about the scope of the new reporting requirements during his speech. So, the apparent intention is that the proposed reporting requirements would apply whether a tax reserve is established for a UTP under FIN 48, IFRS or some other accounting standard.

However, because of differences in the accounting standards for purposes of determining tax reserves, it is possible that fewer UTPs may be identified, analyzed and assessed under IFRS (and other accounting standards) as compared to FIN 48. As a result, if the IRS requires all taxpayers to apply FIN 48 in reporting UTPs, then companies that determine tax reserves

based on IFRS or some other accounting standard may have additional work to do to calculate UTPs for IRS purposes.

Clearly, though, this is another area that will have to be clarified during the comment process, and certainly before the reporting rules and schedules are finalized.

TPCB I would imagine you have been fielding a lot of phone calls on this issue over the past couple weeks. Can you tell us a little bit about how companies have been reacting?

Rob Hanson This has definitely been a big topic of discussion. During a month where the health care reform debate is still going strong and the President has just released the outline of next year’s federal budget, that is saying something!

As we see with the proposal of any new requirement, but particularly in the context of new reporting and disclosure guidelines, the reactions have been pretty diverse. Some companies have expressed concern that, if enacted as proposed, the new requirement might appear to run counter to the existing policy of restraint regarding tax accrual workpapers. Other companies are worried that this effort to create efficiency for the tax authority creates inefficiencies for the taxpayer — they essentially have to perform two related, but potentially very different, processes to account for their uncertain tax positions.

On the other hand, some companies don’t really see the requirement, as it has been introduced, as representing an earth-shaking change. From their perspective, it’s just the next step in an ongoing effort to increase transparency across the board and, frankly, a step that the IRS has been foreshadowing for a few years now.

One thing that has been common to everyone’s reaction, though, is the pursuit of more details and more guidance. We don’t have a lot to go on right now — just the Announcement and the IRS Commissioner’s speech — so we don’t have a lot of clarity on some of the key questions companies might have. This lack of clarity is something that the IRS will have to address in the coming weeks, and we may see some significant scope changes arising from the comment process. “Companies are worried

that this effort to create efficiency for the tax authority creates inefficiencies for the taxpayer.”

“If the IRS requires all taxpayers to apply FIN 48 in reporting UTPs, then companies that determine tax reserves based on IFRS or some other accounting standard may have additional work to do.”


TPCB Can you give us some idea of what kinds of questions companies are asking right now?

Rob Hanson Absolutely. Companies are certainly looking for additional guidance on some of the more operational elements of the proposed reporting requirements. Toward that end, they are asking questions such as:

• What would the disclosure schedule look like?

• How exactly would IRS define “maximum exposure”?

• What would constitute a “concise description” of the uncertain tax position?

• Will the IRS provide more clarity regarding the reporting requirements for private companies?

• Would UTPs need to be reported on the tax return only in the year that they originate or for every year that they are treated as UTPs in the financial statements?

• How would the IRS use the information? Would any part of the UTP information be exchanged with other countries?

These are all very important questions; and, presumably, we will see more guidance on them as the proposal is refined and proposed rules are released. Beyond these questions, though, companies are beginning to look deeper and ask questions about the proposal’s implications and potential impact should the final rules be issued in a form similar to the current proposal. The kinds of questions we are hearing in this regard include:

• How significantly would this requirement affect our tax burden?

• Would there potentially be any tension with auditors on judgments related to the reserve, in terms of reevaluations, whether to establish one, and the amount? Will the documentation in that determination also be an issue?

• How ready are we — in terms of processes, systems and resources — to comply with any new requirement of this type?

• How much more due diligence would be required in signing the tax return?

• How much more involvement could we expect from senior management and the board of directors? And, how could we most effectively handle that communication?

• How would this affect our strategy and approach toward the use of pre-filing resolution tools?

• How would this affect the process and day-to-day interactions of our relationship with the IRS? Or, for non-US multinationals, potentially their relationship with their home tax administration?

Getting to the answers of these questions is what companies are after right now, at least as a first step. More questions will undoubtedly arise as the details of the proposal begin to crystallize and companies begin to share information about the proposal’s potential impact if the final rules are similar to the current proposal. I’d say that both EY and our clients are in serious learning mode right now, trying both to understand the potential implications of the proposal and also beginning to think about the scope of comments that will be submitted to IRS. So, while companies can start the process of understanding the potential impact of the proposal, I think we need more information before they can really do any kind of reliable analysis. And, in any event, things could always shift significantly as the proposal is adjusted in response to comments that the IRS receives.

More solid guidance awaited

TPCB When do you think we will begin to get more solid information and guidance?

Rob Hanson That’s a great question because it highlights the role that companies themselves can play in helping to shape those answers.

It’s important for everyone to recognize that we are still in the proposal stage right now. This is a process the IRS takes very seriously, because they are seeking to maintain a balance between crafting rules that allow them to achieve their goals while also meeting the needs and addressing the concerns of taxpayers.

Toward that goal, the IRS has asked for comments on the Announcement, which they will be accepting through 29 March 2010. I think it’s clear that the IRS is very serious about requiring taxpayers to prepare a schedule for the disclosure of uncertain tax positions with their annual tax return. But, the IRS wants to do it the right way — in a way considers the perspective of the taxpayer and works as well as possible both for businesses and the government.

“Companies are beginning to look deeper and ask questions about the proposal’s implications and potential impact.”

“I view the comment period as a huge opportunity for taxpayers to help craft the rules they will be asked to comply with … the more thoughtful and constructive comments the IRS receives, the better prepared they will be to develop rules that work well for all stakeholders”


I’ve already said it, but I think it is worth emphasizing — the IRS is very serious about wanting to receive input from external stakeholders: taxpayers, their advisors, academics and anyone else with a useful perspective on the issue. Based on this feedback, the scope and implications of the proposal could change considerably before any new requirements take effect, which is not expected to occur for at least one year in any case.

I view the comment period as a huge opportunity for taxpayers to help craft the rules they may be asked to comply with. For that reason, I think that it is absolutely critical for companies to add their voice to the discussion. We are already preparing our comments here at EY and welcome any input we can get from businesses. The more thoughtful and constructive comments the IRS receives, the better prepared they will be to develop rules that work well for all stakeholders.

Impact on non-US companies

TPCB You have touched on the impact that this proposal might have for companies in countries outside of the United States. Do you think that it is worthwhile for them to follow this process closely?

Rob Hanson Without question! This proposal would have very significant global ramifications, both in an immediate and tangible sense and in terms of what it would represent as a tax policy and administration trend.

For example, as we’ve already discussed, if finalized in its current form, the proposal would apply the requirement to any “taxpayer who prepares financial statements, or is included in the financial statements of a related entity that prepares financial statements, if that taxpayer or related entity determines its United States federal income tax reserves under FIN 48, or other accounting standards relating to uncertain tax positions involving United States federal income tax (such as IFRS or other country-specific generally accepted accounting principles).” This definition would include any non-US headquartered corporation with US assets over $10 million to the extent that it has uncertain tax positions of the type required to be reported.

In its current form, the proposal also reinforces global trends identified in EY’s recent Tax administration without borders (TAWB) report3. In addition to identifying trends toward increased transparency around the world, TAWB listed “raising risk to the boardroom” among the leading practices that we have seen from tax administrators around the globe. In setting the context for the UTP proposal, Commissioner Shulman reiterated his view that corporate boards of directors play a pivotal role in providing “appropriate oversight of tax compliance.” The Commissioner stated that, “Tax expenses are like other major expenses. Manage them too loosely and you give up profit. Manage them too aggressively and there are bad consequences. The board must oversee how management manages them.” We are seeing similar efforts to engage corporate boards in many other jurisdictions as well, such as Dave Hartnett (HMRC Permanent Secretary for Tax) speaking at board meetings for many of the UK’s most important taxpayers. With corporate boards being asked to take on a larger oversight and governance role for tax decisions, tax directors should prepare for the possibility of added communication and analysis expectations regarding both the US and global impact of this proposal. For many companies — especially those not subject to Sarbanes-Oxley internal controls requirements — the current proposal would require a closer analysis of tax processes and procedures to ensure that systems exist to identify and quantify tax uncertainties adequately to satisfy these rules.

Also, with many businesses and governments still working through challenges associated with the global economic downturn, I think we also have to look at the possibility that tax authorities might be looking to emulate this process. Many countries around the world continue to struggle with declining tax collections and budget deficits exacerbated by aggressive fiscal stimulus efforts. In this kind of environment, I think it is a reasonable assumption that other tax authorities will be watching the evolution of the IRS’s proposal very closely with an eye to evaluating the possible application of a similar requirement in their countries.

3 www.ey.com/taxadministrationwithoutborders

“Taxpayers have to trust that the new environment will work, and I think that an open, collaborative approach through the development process will be the way to get there.”


Final thoughts

TPCB Thanks, Rob. In closing, can you think of any other things that it might be worthwhile for companies to keep in mind?

Rob Hanson Actually, yes. Regardless of what changes we might anticipate from the comment process, this proposed new requirement for the disclosure of UTPs on the income tax return could be a pretty big shift for the US tax system. In some very real ways, including ways that we can’t possibly foresee, this new reporting and disclosure regime has the potential to impact the way that taxpayers and the IRS interact. Taxpayers would have to have make adjustments to their processes and controls and would need to adapt their approach across the tax life cycle (planning, reporting, compliance and controversy). That would require a significant investment.

Businesses would not be alone, however, in making an investment. The IRS would have to plan for increased administrative and operational demands, in addition to considering broader tax policy implications. They would need to re-engineer compliance processes, adapt workforce behaviors and be willing to have an ongoing dialogue with all of the external stakeholders as this new process unfolds. Some of the implications the IRS would need to consider include:

• There would be more demands for published guidance related to uncertain tax position disclosure.

• They would have to consider and educate the taxpayers of any new requirement’s effect on the policy of restraint.

• They may have to respond to criticisms regarding failure to use current data.

• They would have to refine policy related to exchange of information.

If the IRS is seeking to introduce this new requirement toward a goal of “certainty, consistency and efficiency,” as Commissioner Shulman put it, there will be high expectations for improved fairness and efficiencies for taxpayers as well. That’s part of the “quid pro quo.” The taxpayers would have to trust that the new environment would work, and I think that an open, collaborative approach through the development process will be the way to get there. I believe the Commissioner has clearly signaled that the IRS is committed to just that kind of approach.

Rob Hanson Tax Controversy and Risk Management Services Leader — AmericasTel: +1 202 327 5696 Email: [email protected]

“I think it is a reasonable assumption that other tax authorities will be watching the evolution of the IRS’s proposal very closely with an eye to evaluating the possible application of a similar requirement in their countries.”


Aidan O’Carroll Dave, the United Kingdom, as well as many other countries, has been putting a lot of focus on policies that deal with increased tax competition between jurisdictions in recent years. How do you think that’s affected Her Majesty’s Revenue and Customs [HMRC] in terms of tax administration and how has it affected your view on how this should all be managed?

Dave Hartnett That’s a huge question, Aidan! I think the place to start is if I go back over six or seven years, HMRC and the predecessor departments have invested hugely in getting to know big business leaders and international business leaders much better, getting under the skin of their businesses in a way that we never did before. That, through things like the two reviews of links with business we’ve done in the UK, and through leading the three most recent OECD studies has, I think, helped us, and indeed I think we’ve helped others, understand how business sees tax, how business wants to deal with tax, and it’s enabled us to look at the links between tax and corporate governance and corporate responsibility and all sorts of other issues. But it’s also helped us understand where we need to change our tax system.

I’ll pick a few things at random; the substantial shareholdings relief was a competitive measure that the UK introduced because some others had gone there already, but actually business had planned around the issues now covered by the relief and so it seemed sensible to do this. The more recent move towards a territorial system of taxation is about competition and similarly the debt cap is part of that story as well.

Looking more closely at administration, I think some of the really crucial precepts of the study of tax intermediaries for the OECD

have also been things that we, working with others, have shaped. The only outcome of an audit should not be an increased tax bill, but that greater certainty is needed by business, and I think that that’s a competitive issue. You could compare some extremes for example — take India and the UK. A tax appeal in India can take 35 years to complete, while five years in the UK may feel like quite a long time. So that’s some indication of the sorts of things I think about.

Aidan O’Carroll When you start to bring that down to a tactical level and look at the areas that potentially concern you most from a risk perspective, what strikes you as the key areas to be concerned about?

Dave Hartnett I think the first thing is to actually monitor the flows of capital. It’s probably something that 10 years ago we didn’t do very well; today we do it much better and we monitor very carefully. It gets you very close, very quickly, to some issues of tax planning and tax avoidance, shifting intellectual property out of the UK and out of other countries into low tax centers. We both monitor and challenge arrangements like that. And although it isn’t a capital flow issue, the monitoring and challenging corporates which claim to have moved their residence is very important to us also.

Hartnett on tax administrations working together:

“I think it [JITSIC] has been hugely effective, but I would say that, wouldn’t I! You can actually today measure the effectiveness of JITSIC. It was in JITSIC that the UK was able to share with the US and Canada, and more recently Japan, how foreign tax credit generators were operating. I remember being at a conference in the United States when the US Treasury official said “thank you to our JITSIC partners in the UK who found foreign tax credit generators for us.”

Aidan O’Carroll, Global Tax Markets Leader

Tel: +44 207 9800789 Email: aidan.o’[email protected]

An interview with Dave HartnettPermanent Secretary for Tax — Her Majesty’s Revenue and Customs [HMRC]


On tax administrations working together

Aidan O’Carroll If we look outside of the UK at the ways in which tax administrations are increasingly working together, do you see the creation of the Joint International Tax Shelter Information Center [JITSIC] organization as having been an effective instrument? And where would you like to see it going over the coming years?

Dave Hartnett I think it has been hugely effective, but I would say that, wouldn’t I! You can actually today measure the effectiveness of JITSIC. It was in JITSIC that the UK was able to share with the US and Canada, and more recently Japan, how foreign tax credit generators were operating. I remember being at a conference in the United States when the US Treasury official said “thank you to our JITSIC partners in the UK who found foreign tax credit generators for us.” I think the big thing about JITSIC in particular is that we are today sharing information within bilateral treaties, days no more than weeks after an event, rather than years as it used to be. I think JITSIC raises some very interesting issues. Another Big Four partner was very critical of JITSIC at the start but more recently has been saying that JITSIC does good work because it also enables tax administrations to see some of the things they shouldn’t necessarily be pursuing, and to see them quickly. And don’t forget that by raising issues relatively publicly it gives business a good sense of what it (JITSIC) should be pursuing and what it’s better to stay away from.

On the potential future of tax audits

Aidan O’Carroll If I can take that a stage further, when you think about both the concept and reality of what I would call multilateral or simultaneous tax audits, do you see the practice of information sharing happening in real time?

And not just in JITSIC but in other mechanisms or forums as something that would create greater efficiency or greater opportunity for the tax authorities to try and get their fair share of tax?

Dave Hartnett I think moving forward, this will happen very quickly: we will see more joint audits between nations, we will see the beginning of tax authorities saying to multinationals, “well the US is going to audit you in North

America, the UK will audit you in Europe, Australia will audit you in the Pacific and we’ll use our treaty networks to join all that up.”

I think that’s coming and I think it will be a very effective way of tax administrations getting their work done. It will be a different way of sharing information but nonetheless a very effective way of doing it.

Aidan O’Carroll When we think about the financial crisis that the world has experienced over the last 18 months or so, we have large, immediate and potentially long-lasting budgetary deficits all over the world that are going to have to be dealt with. There is clearly a balance between what can be done through the cutting of public expenditure, but from your tax administration perspective, what challenges do you think that now presents you with, given your current focus on building bigger deeper relationships with the largest corporates and potentially at the same time these are the very same corporates that are going to have to be squeezed in order to raise revenues?

Dave Hartnett I’m not sure that’s really right, Aidan. Let me try and chunk up the answer a bit for you. I think it’s probably more important today than ever before, given governments’ need for money that we are effective in countering tax avoidance and effective in uncovering tax evasion and that we do that work just as quickly as we can. What I don’t think is part of our objective at all is simply to squeeze multinationals or other business just to get more money out. So you wouldn’t start running different arguments on technical issues in the hope that a tougher approach produced greater tax payments.

I think it’s not just a business tax issue though Aidan as well; if you look at the work we’re doing with tax havens, a lot of which has been fortified by the need for countries to stem losses through tax evasion, the changes there have been in transparency, increased number of treaties and tax information exchange agreements, the work that the UK has done with the Lichtenstein government to open up Lichtenstein and the work that we and others are doing with other countries as well. So actually that’s a big part of it and I never thought as a tax inspector that we would open up Lichtenstein on a mutually-agreed basis with the country in my lifetime. I think most tax administrators would have said the same. So there’s a big piece there as well changing emphasis in relation to tax havens and the increase in global cooperation to deal with this.

Hartnett on joint and simultaneous tax audits:

“I think moving forward, this [joint and simultaneous tax audits] will happen very quickly: We will see more joint audits between nations, we will see the beginning of tax authorities saying to multinationals, “well the US is going to audit you in North America, the UK will audit you in Europe, Australia will audit you in the Pacific and we’ll use our treaty networks to join all that up.” I think that’s coming and I think it will be a very effective way of tax administrations getting their work done.”


On the UK disclosure schemes

Aidan O’Carroll I suppose looking back with hindsight you had to be pretty entrepreneurial in your approach to actually make that happen?

Dave Hartnett Take what we’re doing in the UK at the minute. If we can obtain information about someone’s offshore bank account by issuing statutory information notices to a bank operating in London, then we want to recover all the tax, interest and penalties we can, and in the UK, that means going back or up to a maximum of 20 years. If we’ve actually got no levers at all, other than maybe reputational challenge, we can’t force data out from particular banks, and then you have to find some compromises, some incentives, and some other ways of dealing with it. So yes, likening it to “entrepreneurial” is probably OK with me.

Aidan O’Carroll But clearly not everyone with an offshore bank account is guilty of tax avoidance or tax evasion? In fact I imagine that the majority of offshore bank accounts are run for perfectly legitimate and understandable reasons. Is there a danger that any individual with an offshore bank account as a result is made to feel guilty by the politics of the situation? Is that something that you feel you’ve got a role in trying to help to temper or manage? Or is it just from a tax authority perspective you have the specific jurisdictional role to play to collect, as you say, the correct amount of tax from any undisclosed offshore bank account that up to now had been disclosed?

Dave Hartnett Yes, we do have a statutory obligation to collect taxes which haven’t been paid. Having said that, we are at pains in all our communications to say that we know lots of people have offshore bank accounts for legitimate reasons and disclose their income from those accounts in their tax return. That said, in the UK, about 20% of people with offshore bank accounts have used them to hide income profits, gains, inheritance tax liabilities and the like. It’s those 20% we want to find. But we have no interest whatever — and try very hard to make sure it doesn’t happen — in excoriating people simply because they’ve got an offshore bank account.

Aidan O’Carroll If we take another look at how tax administrations are working more closely together, I would venture that we’ve seen a number of tax administrations — of which I would say the HMRC is one of the leaders —

where leading practices seem to becoming more broadly interdependent, being adopted by one country and then replicated by others.

I’m thinking here about things like risk ratings, advanced compliance agreements, alternative dispute resolution, organizations like the African Tax Forum. Do you see this increasing and if so, what kind of administration processes do you think are going to attract the most interest?

Dave Hartnett Well I find it really interesting that you put the African Tax Forum in there because I think about that in a very different way. Africa was a continent that had no forum for its tax commissioners until the African Tax Forum was established last year. I saw it as an African initiative where African tax commissioners help themselves and help each other.

The UK and a number of other countries have been heavily involved to help them to do this.

Why are we doing that? Well, it’s because we see that they’ve got lots of challenges — I mean there are still sub-Saharan African countries that may be mineral-rich, for example, but what they get in aid still exceeds what they raise in tax, which, at the end of the first decade of the 21st century, doesn’t sound like the right way round. So we’re piling in to help. So I see that really rather differently.

Hartnett on Africa:“There are still sub-Saharan African countries that may be mineral-rich, for example, but what they get in aid still exceeds what they raise in tax, which, at the end of the first decade of the 21st century, doesn’t sound like the right way round. So we’re piling in to help.”

Hartnett on achieving certainity:

“It seems to me that it’s not enough for a large corporate say “we want tax administrations to be commercial, we want them to provide greater certainty, we want them to do this that and the other” and then to stand back and wait for it to happen.”


On risk rating companies

Aidan O’Carroll Maybe some of the other examples then, risk ratings and risk reviews as an example of things that are becoming more common. Can you foresee that the multinational enterprises will be rated on perhaps a bilateral or even multi-lateral basis, in real time, by different administrations around the world?

Dave Hartnett Maybe. Part of the difficulty, the challenge for risk rating, is that we in the UK want to use risk rating to enable us to determine how we apply our resource, particular tax risks and to identify those businesses. But we do it with individuals as well, so that we can trust them to get on with their tax affairs and pay broadly the right amount of tax. Now what I think has begun to emerge over the last few years is that some multinational companies pose a different level of risk in different countries partly because of the way the different tax systems are constructed. I can see more discussions opening up in this area. You know we talked about joint audit earlier on, I can see more discussions opening up about risk in relation to joint audit and so on. But I’m not sure whether we’ll ever get to what’s implicit in your question or in the foreseeable future anyway, which is sort of sharing numeric risk ratings between countries.

And that’s because I think they are inevitably quite subjective and I would be concerned about them not being fully understood.

On the mutual desire to achieve certainty

Aidan O’Carroll If we move back to businesses, in terms of a general principle, both tax administrations and multinational companies desire certainty or as much certainty as they can get within their tax affairs. A two-sided question here in terms of what do you think multinationals could do from your perspective to achieve more certainty, and what are you doing to help the multinational?

Dave Hartnett Aidan, I don’t know how you’ve done it but you’ve been reading my mind! I’m giving the Hardman lecture next week at the Institute of Chartered Accountants and this is exactly what I’m in part going to be focusing on.

It seems to me that it’s not enough for a large corporate to say “we want tax administrations to be commercial, we want them to provide greater certainty, we want them to do this that and the other” and then to stand back and wait for it to happen. The other big issue is that it’s not enough for people like me to speak out on tax issues if we don’t drive the thinking down inside their tax administration.

My response to the question on multinationals, is that, particularly in the UK, business is not doing enough to work with HMRC because we need these businesses to offer secondment opportunities and to show our people what, in their minds, “being commercial” actually means. If I can have just a little poke in the ribs at the Big Four accounting firms at the minute, it’s still pretty rare for you guys to take any of our people in on secondment and the usual explanation is because “our clients won’t like it.” But we take your guys in a very trusting way and none of them have ever let us down. I think I’m going to be saying next week that there’s a great deal more that business and their advisors can do in order to develop the tax administrations they want.

Aidan O’Carroll Staying with the topic of advisors, do they practically help you as an administration to identify the key areas where legislation could be more effectively drafted, where key issues could more effectively be identified rather than relying on the plethora of anti-avoidance measures that come out? Is that something that you look at on a proactive or a reactive basis?

Dave Hartnett That’s something we look at on a pretty proactive basis. But let me get one of the difficulties on the table. Whilst we have a very strong relationship with Ernst & Young and some others and with the big city law firms, there are lots of boutiques and others which we have no relationship with at all and who would exploit any weakness we left in legislation or in practice. That’s sort of a backdrop for what I’m going to say but here at HMRC we see representatives from the big city law firms and the Big Four accounting firms quarterly to pick up issues of their choosing or ours.

We look at the operation of the law; we look at how sensible changes can be made. When we have got ourselves into some difficulties in the past, maybe HMRC and the Treasury, I think of reform of IHT (inheritance tax) and trusts for example and reform of the Residency and Domicile

Hartnett on tax controversy:

“I sense as well that both taxpayers and tax administrations are readier than perhaps in the past to say “okay, we’ve got to litigate” and to say that at a very early stage.


rules. When it was clear that we didn’t really understand the whole context in which we were operating, I turned to the Big Four accounting firms and the city law firms and said help and no one knocked me back. Everyone came in and rolled up their sleeves and explained to us things that we just had no idea about.

So I think we need to grow that more, although it does work pretty well already.

On managing tax disputes

Aidan O’Carroll Let’s move into the enforcement area. Clearly HMRC is not unique in this, but using a litigation approach in terms of getting things more quickly into the legal process, has become in some jurisdictions quite an increased feature of the tax system. When I think about other ways of being able to resolve disputes without having to go through more expensive and time consuming litigation, alternative dispute resolution comes into mind as being a key growth area. In terms of the coming years, do you think we’re in for more litigation, less litigation, about the same or do you think we’re going to start to come up with more negotiated face-to-face deals?

Dave Hartnett Let me sort of duck the question for a minute and then come back to it. What I’m fairly confident will start happening is if you look at the technology court in the UK, which is part of the High Court, they require some form of mediation or Alternative Dispute Resolution [ADR] or whatever, to have taken place before proceedings actually start in the court. I’ve been party to that in the context of wanting to recover compensation on a technology issue and having to go through that. I can see real merit of that in relation to taxation where before you get into the High Courts, you have to do something like that.

One of the concerns I have about tax and litigation — and I get a sense that round the world — is that there is a growing feeling on the path of both private sector advisors and tax administrators that transfer pricing should be litigated. I’m really not convinced of that, though. Clearly you have to litigate it if the ability to reach a resolution breaks down completely. The litigation around valuation, around interpretation of fact, around costings and the like seems to me to be very subjective and to depend on the mood, inclination, understanding et cetera of judges rather than being about interpretation of the law.

I sense as well that both taxpayers and tax administrations are readier than perhaps in the past to say “okay, we’ve got to litigate” and to say that at a very early stage. But equally I have a sense — and I think it’s true in the UK and I’m sure it’s true in other countries — that this gets said by people who’ve never been through major tax litigation and haven’t seen just how challenging it can be. So I think there’s a lot said about increasing litigation, without there necessarily being a huge increase in litigation. So I do agree with something that you’ve said implicitly in that the stakes today have probably never been higher than they are now in some of the cases that get litigated.

Aidan O’Carroll I know a number of tax authorities provide what I’ll call a “clearing house,” as in clearances in advance as an embedded part of the tax system. Do you think from HMRC’s point of view, where you do already have some form of that in place already, that it’s an instrument that you could use more in order to create that additional level of transparency, co-operation and certainty with corporates?

Dave Hartnett I do. I think advanced clearances of this nature are an absolutely essential part of good tax administration. They’re actually quite resource intensive and expensive for the tax administration, but I’m a big fan and I think the way the UK has developed in the last two or three years is really good.

I think you’re also very close to asking another question so I’m going to answer it, about the whole area of how we handle disputes. I’m very attracted to the approach I’ve seen in the US and one or two other countries of where you’ve got a really serious dispute of having an internal, “independent,” review before the button is really pressed for litigation to start.

I think that part of my role in HMRC is sometimes to say to all of our people, “this (issue) is not really for litigation, we can’t do it.”

But equally I have a sense — and I think it’s true in the UK and I’m sure it’s true in other countries — that this gets said by people who’ve never been through major tax litigation and haven’t seen just how challenging it can be.”


Aidan O’Carroll The perception in the past was that the solicitor’s office played part of that internal independent review.

Dave Hartnett Possibly. I mean we tend to use our lawyers in only two ways. We use them for advice and we use them to litigate. We tend not to use them in any sort of mediation system but I think that is something that we could make more of.

Aidan O’Carroll So you’re clearly in favor of advanced rulings which will help certainty. What then of corporates outside of your jurisdiction who get advanced rulings themselves with another tax authority in connection with a commercial transaction? These would obviously not be binding on other tax authorities to follow, but would you look more favorably on corporates who have gone through the process of getting these advanced rulings with other tax authorities?

Dave Hartnett Well, I think the answer to that, I’m afraid, is that it all depends. You’ve only got to think briefly about check-the-box rules in the United States to see how something that was subject to a clearance application there, might get one answer in the United States but the answer in the UK could be completely different. Whilst one might be mildly impressed by a company going to get a ruling, I suppose I worry much more about them getting a ruling in the United States and us being unable to accept the consequences of that ruling or the transaction in the UK because our law just works so very differently.

Aidan O’Carroll To wrap up, Dave, what messages would you like to pass on to people reading this? Is there anything that we haven’t covered or any particular message that you’d like to pass on?

Dave Hartnett I’d really like to repeat two words I’ve used a couple of times. I have a very strong sense — it probably comes with old age — that tax administration can be more effective and more cost efficient for everybody if we can build in more transparency and trust.

And it cuts both ways; business needs to be able to trust tax administrators and tax administrators need to be able to trust business and we should all do so on the back of transparent behavior. And behavior is an important word here, but transparent behavior. Also, while I have no difficulty with very clever advisors doing very clever planning, I have real difficulty with advisors who slip from clever planning into very aggressive avoidance. And I’d like therefore advisors to be more transparent and to value the trust the tax administrators are ready to place in them.

Dave Hartnett

Permanent Secretary for Tax, HMRCwww.hmrc.gov.uk

Aidan O’CarrollGlobal Tax Markets LeaderTel: +44 207 9800789Email: aidan.o’[email protected]


The following is an excerpt from Ernst & Young’s recent “Tax administration without borders” study. You can read and download the full study at www.ey.com/taxadministrationwithoutborders where you can also replay a recent Ernst & Young webcast during which the study findings were discussed.

Globalization and a shifting economy driving major changes

Globalization is dramatically shifting the flows of capital around the world. It’s re-balancing economic influence from west to east. It’s interconnecting global economic fortunes.

It’s also causing businesses to re-frame their decision-making processes and look to emerging markets in their efforts to grow and become more efficient. Financial market distress and economic downturn have hit every industry and every part of the world hard, straining even businesses with solid foundations.

The challenges of a shifting economy have forced businesses to search for efficiencies wherever they can be found —

in the workforce, in the supply chain and within the organization. Not just business has been changing, either. Governments too have had to work overtime to keep pace with a changing environment. Like businesses, they are competing for position in the new global era even as they thirst for revenue. And, with tax collections lagging and deficits rising — despite early signs of economic recovery — governments are focused more than ever on collecting the amount to taxes they consider are due.

The result has been a succession of legislative and regulatory changes and a continuously evolving tax administrative approach that have added a new layer of complexity that tax directors — and, increasingly the c-suite and boards — must grapple with every day.

Four trends changing the face of tax — and leading to a rise in tax controversy and risk

Accelerating pace of globalization

Changing model for tax administration

Rapid succession of legislative and

regulatory changes

Shifting economy

Bob Brown, Global Director — Tax Controversy Services

Tel: +44 (0) 207 951 4724 Email: [email protected]

Tax administration without bordersNavigating the changing global tax controversy and risk management landscape


An explosion in tax controversy and risk

Even though tax authorities have been making changes that they hope will create better alignment with businesses, the result has not necessarily been greater harmony. In fact, in most cases it’s been just the opposite. Whether it’s because companies are doing business in more countries, or governments are ramping up enforcement efforts, we are experiencing a dramatic rise in cross-border conflict and an environment filled with more tax controversy and risk — financial, reputational and, increasingly, personal — than ever before. And, as companies continue to expand their global footprints, they are increasingly feeling the impact.

Successfully managing global tax controversy and risk

Companies that plan for controversy before it happens can successfully address this challenge. They can achieve greater certainty. They can release cash from the provision. They can reduce their tax compliance costs and free up their best people from managing complex tax controversies and litigation. And, importantly, they can improve their relationships with tax administrators. In a world where cash remains tight and the best people are always in significant demand, these are compelling reasons to get tax controversy and risk management strategies right.

Ernst & Young has compiled a list of leading practices that businesses should consider in helping to better manage global tax controversy and risk:

Increased transparency

Targeting specific

situations/ issues

Cross- border/

joint enforcement

issues

Risk rating of

companies

Raising risk to the

boardroom

Joint audits

Acceleration of audit

cycle

Increased sharing of

information by tax

authorities

Accelerated issue

resolution

Enforcement trends

Your agenda for change

Stay connected with tax policy and legislative

changes

Include global

tax risk as a corporate governance

issue

Evaluate global

systems and resources for tax risk

management

Adopt a global approach to tax

controversy and risk

Manage potential and ongoing controversies at

a strategic level

“Companies that plan for controversy before it happens can achieve greater certainty, release cash from the provision, reduce their tax compliance costs and free up their best people from managing complex tax controversies and litigation.”


Adopt a global approach to tax controversy and risk

Tax authorities are applying more scrutiny to taxpayers with higher risk profiles and are rewarding taxpayers that have lower risk profiles. Therefore, the relationships developed with tax authorities are likely to become more important, as is taxpayers’ willingness to collaborate to resolve issues fairly and quickly. This kind of taxpayer information is likely to be shared among tax administrators so they can make informed global risk assessments and identify likely candidates for joint examinations.

The focus by tax authorities on risk rating provides companies that want to invest in transparent relationships with the opportunity to reduce exposure to controversy, penalties and interest payments, while freeing up valuable resources.

Among the characteristics that might be considered in the risk assessment are the aggressiveness of tax positions taken on the return, internal controls and governance. Behavioral factors, such as responsiveness to requests for information and documents, transparency and collaboration, may also be taken into account.

Business leaders also have opportunities to participate in forums and joint meetings with tax authorities seeking an external stakeholder view. Active participation in these settings can help inform the tax administrator and create a better understanding of one another’s interests and business objectives to find the “win-win” solution.

Evaluate global systems and resources for tax risk management

Managing future controversy requires the understanding of both the scope and direction of a likely tax audit or examination. Companies need to try and make sure that the right processes are in place to manage the risk of potential tax controversy. Additionally, this should be done at the time the decisions giving rise to that risk are made and implemented, which often is long before the tax return for the relevant year is filed. Effectively managing these risks before filing a tax return can significantly reduce exposure and financial risk.

Global tax risk management systems should have processes in place to identify, assess, measure, mitigate and monitor actions and strategies. While many tax functions may have designated “tax risk manager” and “tax controller” positions to monitor and manage tax risks on an ongoing and proactive basis, controls and procedures should be integrated into the various tax and business processes as far upstream as possible and not be treated as separate activities within the tax function.

An absence of skilled resources can contribute to tax risk. Companies also struggle to train the people they have. Managing resources in overseas locations presents additional challenges. A tax function will need to consider either hiring suitable skilled and experienced people or engaging an external advisor where the appropriate skills do not exist.

In order to effectively manage controversy and risk across the enterprise, many leading companies have adopted an approach that considers the entire tax lifecycle — planning, provision, compliance and controversy — as an integrated process. Before making a strategic or tactical decision on any type of tax, the decision’s impact across each phase of the tax lifecycle is considered. Some companies are establishing risk management councils within their companies; others are relying on their internal audit functions to perform a stronger role.

Manage your ongoing and potential controversies at a strategic level

Comprehensive tax controversy and risk management strategies will help companies anticipate potential controversy issues, avoid unnecessary disputes before they occur and effectively mitigate the impact of any disputes that do arise.

For positions that have already been reflected in filed returns, companies should identify, quantify and evaluate potential tax risks and exposures in light of existing documentation and the enforcement activities of the jurisdictions where those returns were filed. This provides the opportunity to mitigate the risks by enhancing documentation and considering dispute resolution options or voluntary disclosure opportunities.

“Among the characteristics that might be considered as part of a risk assessment are responsiveness to requests for information and documents.”


A tax audit in a single jurisdiction can involve managing a number of moving pieces; navigating tax audits in multiple jurisdictions can be even more challenging. Companies should establish protocols for responding to examination requests, develop specific response mechanisms for each jurisdiction and ensure that information provided in one jurisdiction is consistent with the responses given to inquiries in other jurisdictions.

For issues that advance to the controversy stage, assess the relative merits and weights of each issue and analyze the merits of disputes with tax authorities. For cross-border issues, consider how a settlement or adjustment in one jurisdiction will affect other jurisdictions.

Include global tax risk as a corporate governance issue

Tax administrations are working diligently to elevate tax strategy on the boardroom agenda. They are increasingly expecting corporate boards to understand their responsibilities with regard to their business tax strategies and outcomes. CEOs and boards are increasingly considering tax risk management as part of overall corporate governance. Audit committees are expanding their focus from issues of tax compliance to tax risk management.

Stay connected with tax policy and legislative change

By understanding the context in which tax policy decisions are made, and assessing the potential impact of new legislation on existing and planned tax positions, companies can get a head start on implementing a pre-controversy strategy.

Advanced knowledge and understanding of global tax policy trends can minimize the adverse impact and position companies to benefit from any changes or allow the company to take proactive steps to adapt to changes and even engage with policymakers to contribute their perspective to the legislative process.

What the future holds

We have experienced significant change over the past few years — and we believe that the pace will only accelerate. As governments and businesses reflect on lessons learned from the global economic crisis, we will see regulatory policies redrafted, businesses reinvented, industries redefined and new markets created.

Some trends we see taking a more active hand in reshaping the global tax landscape include:

• Even more information sharing

• The development of global risk profiles

• More joint and simultaneous audits

• Increased use of pre- and post-filing resolution processes to gain certainty

• Use of tax return disclosures to address greater demand for transparency

• Tax policy changes driven by deficit reduction and global competition

• Greater use of financial statement reporting in tax

• Increased governance

Companies that are likely to succeed today and tomorrow are those organizations considering tax controversy within an integrated tax lifecycle approach. They will be incorporating tax risk management into the very core of their business.


Conclusion

The world in which multinationals operate today is dramatically different from the one in which they operated a year ago. A year from now, it is likely to be different still. Adapting to these shifts requires global companies to think in new ways about their tax positions and their overall approach to managing tax risk. They must be more nimble, especially when it comes to engaging with tax administrations and working in new ways to resolve or avoid potential disputes before they occur.

Those that are likely to succeed will be considering tax controversy within an integrated tax lifecycle approach. They will be incorporating tax risk management into the very core of their business — from the boardroom, to the C-suite, to operations on the ground in their various taxing jurisdictions. They will understand that establishing a global tax vision is not a luxury, it is a necessity, and that considering their strategy along with the goals of their key tax administrations is more important than ever. As tax administrations step up their cooperation with their counterparts in other nations, businesses can no longer afford to act in isolation. A misstep in one country may have reverberations around the world.

As governments and businesses reflect on the lessons learned from the current crisis, we will see regulatory policies redrafted, businesses reinvented, industries redefined and new markets created. It is not a time to rely on the old ways of doing business; it is a time to embrace change. The risks are real. Getting your global tax risk management strategy wrong can mean irrevocable damage to your company’s finances and reputation. But getting it right can yield significant benefits.

Visit www.ey.comtaxadministrationwithoutborders for more information.

Bob BrownGlobal Director — Tax Controversy ServicesTel: +44 207 951 4724Email: [email protected]


Todd Immell, Partner — Ernst & Young


An interview with Tim McDonaldVice President, Finance & Accounting, Global Taxes — Procter & Gamble

Todd Immell Tim, how have your relationships with tax authorities changed in both the developed and emerging markets over the last year, year and a half?

Tim McDonald We are certainly seeing more aggressive tax audits and more positions that appear to not be fully consistent with OECD principles. Some auditors in both the US and in some other countries seem to be saying “we need the money.” These exchanges are surprising, particularly for developed, OECD countries because there is little if any reference to tax principles or policy other than revenue generation.

On managing joint audits

Todd Immell Joint and simultaneous tax audits certainly seem to be growing in number and popularity with tax administrations as tax authorities work more collaboratively with one another. Have you been involved in any joint or simultaneous tax audits?

Tim McDonald Yes, we have had a joint and simultaneous audit involving six EU member countries. The country that initiated the joint audit process had a very aggressive and unconventional permanent establishment and transfer pricing theory. Apparently they thought that by inviting other EU member tax authorities to join their audit, they might be more successful in the assessment and collection of increased tax. Fortunately for us, a number of the countries that agreed to participate in the joint audit were already well into the process of auditing us and or processing our Advance Pricing Agreements(APA) ruling requests, and they did not agree with the proposed unconventional approach. We ultimately

resolved all of the other audits and obtained very reasonable APAs, leaving the initiating country alone with its unconventional theories. Resolution of the remaining audit is now before the competent authorities.

Todd Immell Does your tax function actively pursue a strategy to reduce or even remove tax controversy and if so, what do you see as the most effective methods?

Tim McDonald Yes, we absolutely do. We have had some intense tax audits. The longest was a seven-year ongoing discussion, but in most cases, including that longest audit, we have resolved the audits and have managed to convert them into an APA, and in most cases they are bilateral APAs. I am a firm believer in an APA strategy, if you have strong facts and you have a similar business model throughout your operations. Our tax risk management strategy is predicated on leveraging our strong facts into successful audit resolution and APAs. Our APA tax strategy is predominately focused on our largest non-US markets. We believe that our APA strategy gives us greater predictability and financial statement precision not only in markets where we have obtained rulings but also in other countries with similar circumstances where we have yet pursued a ruling. Essentially, because the business model is the same and the circumstances are similar, our rulings give us the ability to ask the next government, why shouldn’t the new audit produce the same tax result as the 15 APAs that we have already obtained on substantially similar facts. When we couple this strategy, with our general corporate transparency, and global consistency in execution of our planning, and strong internal controls, we have a strategy that delivers more risk management certainty.

Tim McDonald on tax enforcement:

“We are certainly seeing more aggressive tax audits and more positions that appear to not be fully consistent with OECD principles. Some auditors in both the US and in some other countries seem to be saying “we need the money.” These exchanges are surprising, particularly for developed, OECD countries because there is little if any reference to tax principles or policy other than revenue generation.”


On tax policy

Todd Immell We are seeing more multinationals engaging with governments around the world to help them understand global business needs and formulating appropriate tax policy. I know this is an active area of interest for you. What experiences have you had in this area?

Tim McDonald Well, it’s very clear to me that there are two trends that are affecting tax policy and which seem to be converging. One is a longer-term trend of competition driven by globalization. Most tax administration officials have worked their entire career in government and have no direct business experience. Therefore, it is important to explain how our business operates today and how it continues to evolve. This dialogue is important not only for the resolution of an audit but also for the productive evolution of tax policy. At its most basic point, to raise tax revenue successfully on incorporated business income, one of the policy goals should be to ensure that the underlying law allows all corporations to compete without obstacles built into the tax system. To do otherwise can jeopardize the government’s revenue stream over the long term.

The classic example of the latter is the history of Subpart F changes over the last 25 years for the international shipping industry. The US adopted tax policies in 1986 that were dissimilar and uncompetitive to the rest of the world, which caused the US to go from owning approximately a 25% share of the worldwide international shipping business down to nearly 0% by 2004. Thus, between 1986 and 2004, the US raised much less revenue on the US multinational’s international shipping business income.

When we discuss our business and the competitive challenges that we face and our need to evolve to respond to external competitive forces, we attempt to gently provide the linkage to its implications for government. The fact is that a government’s revenue and their economy’s employment, GDP multiplier effect and overall economic growth are tied to domestic and global businesses’ success in the market. Corporate income tax is therefore also vulnerable to globalization pressures and the need to be relevant, competitive and compatible with the tax systems of alternative investment locations and strategies. Stated differently, a tax system that does not consider the dynamic consequences of its attempt to raise revenue will fail. A tax system focused only

on revenue generation and the perfection of the theoretically most pure tax policy, irrespective of international norms, would likely be a only short-term revenue generator that would not likely attract the next Microsoft or Google to make a home in that country. Many countries understand this dynamic while others ignore the bigger picture.

The other more recent development is the financial crisis and its impact on government budgets. Not every economy has been shattered but many of them have been harmed and the revenue cycles and the amount of capital in many markets is not what it was two years ago. Different countries are therefore responding to these pressures differently. Unfortunately, in the United States, the rhetoric currently doesn’t seem to be helpful. We are making the case that under US corporate tax reform, the system has to be rational, competitive and globally consistent with the significant trading partners of the US.

On achieving certainty

Todd Immell If we shift from the policy side of the coin and onto tax administration, one of the shared objectives we are seeing continue to develop is that both tax administrators and multinational corporations are trying to achieve more certainty, sooner. Is this one of your objectives? I know you are interested in the Compliance Assurance Program (CAP) program in the US, for example. Do you feel that you are achieving more certainty, the same certainty or less certainty with your major taxing authorities say in the last 12 months?

Tim McDonald Well, in the last 12 months we have solved two substantial foreign tax controversies or audits and converted them to APAs, so that has been a really positive step for us. We have also been designated as a low risk taxpayer in those two countries similar to a CAP taxpayer designation in the US. On that basis, we were able to release reserves, and we have resolved controversies. For us, the US seems to be elevating once again the tax controversy risk. I think CAP is an interesting idea. We are currently not in CAP in part because we are currently in litigation and are therefore not invited to the program. My former company actually has been in CAP for 6 years. I think if you can get all the issues understood and scoped, then it’s worth doing.

Tim McDonald on managing tax risk:

“When we couple this [APA] strategy, with our general corporate transparency, and global consistency in execution of our planning, and strong internal controls, we have a strategy that delivers more risk management certainty.”


For multinationals, one of the largest sticking points is that the transfer pricing economists and international examiners quite often do not agree to resolve the audit in a timely manner — the way CAP is intended. And so if that’s what occurs it’s not a good deal. What you have done in that circumstance is extended the duration of the audit without any improvement in predictability and certainty.

You have extended your audit effort and budget expenditure without any gain; it’s a one-sided gain for the IRS. I have heard many of my peers question the logic of being in CAP when they can’t resolve the key issues that are in front of them. I think if the IRS can figure a way to accelerate either through national office intervention or rulings mechanisms or APAs to make all the issues timely resolved, CAP is a great answer.

Todd Immell Tim, if we look at P&G, clearly you are involved in some pretty interesting emerging markets. What are your biggest challenges in dealing with what I might term as “non-standardized” taxes and tax administration in these markets?

Tim McDonald The two countries where we experience the most complexity are probably Brazil and India. In both cases, there is just a myriad of indirect taxes. To give you a sense of it, in Brazil about 60% of the selling price of a typical consumer product is comprised of the approximately 50 different indirect taxes. That’s also compounded by Brazil being a confederation of states in contrast to a uniform national centralized tax system. So in Brazil you have different states with different rules which are unconventional and “non-traditional OECD rules based.” Additionally, in both Brazil and India, there’s another challenge; it’s very difficult to settle anything unless it’s black and white, in which case you can resolve it. I am told that gray interpretative issues are very difficult to settle at the audit level in part out of a concern that the auditors do not want to be accused of corruption. They therefore write it up, and cause you to litigate, rather than have a business discussion about how to resolve it in a principled but practical manner at the audit level. That in part explains why we have over 200 tax litigation cases pending in both Brazil and India.

On alternative dispute resolution

Todd Immell That leads me nicely into my next question Tim — alternative dispute resolution processes are growing in popularity as tax administrations try to find ways to reduce the burden of litigation. What are your views on ADR and how willing is the company to enter into these kinds of arrangements?

Tim McDonald It really would depend on the circumstances in each country. Of course, we are very actively interested in obtaining predictability and timeliness of any favorable resolution. I think more than anything, FIN 48 drives you to pursue faster resolution if it is reasonable. The methodology is different under FIN 48, as you know. There are two key items that cause FIN 48 to motivate you to think differently.

The first is that you often have situations where according to administrative practice, in theory, there are penalties or supercharged interest assessed on a tax dispute. But in practice, because it’s factual, you almost always resolve it without the imposition of the higher level of interest and/or a penalty assessment. In these situations, FIN 48 does not allow administrative practice to be evaluated. That means, at least in our experience, we seem to be over accruing for anything that is in dispute or uncertain and the longer you leave it outstanding the more you accumulate and that’s a pretty expensive proposition.

The second, bigger issue with FIN 48 is you actually never get earnings credit, even when you have a pretty stable pattern of similar discrete non-material tax reserve releases. We believe that the analysts look at the annual FIN 48 footnote and now completely disregard tax reserve releases. Essentially we believe they ignore tax releases because they can not assess whether they are sustainable for the future even if you have a pattern of regularly releasing tax reserves in the past. And so it’s kind of strange in that the people that are the most conservative on accounting actually are getting the least credit for what are real earnings and cash flow! So these two factors drive us to consider strategies that offer alternative dispute resolution opportunities.

Tim McDonald on the US Compliance Assurance Program (CAP):

“I have heard many of my peers question the logic of being in CAP when they can’t resolve the key issues that are in front of them. I think if the IRS can figure a way to accelerate either through national office intervention or rulings mechanisms or APAs to make all the issues timely resolved, CAP is a great answer.”

Tim McDonald on managing uncertain tax positions:

“The second, bigger issue with FIN 48 is you actually never get earnings credit, even when you have a pretty stable pattern of similar discrete non-material tax reserve releases. We believe that the analysts look at the annual FIN 48 footnote and now completely disregard tax reserve releases.”


Todd Immell Risk assessment process is becoming an integral way for tax administrations to identify audit targets. How aware are you of the different risk assessment processes used in the major jurisdictions and what did you do to make sure you are perceived as a low risk taxpayer?

Tim McDonald Well, we start with explaining how we run the business, because we think if they understand that a lot of potential issues will fall out favorably earlier in the audit. As I mentioned, we are currently risk assessed as low in a couple of countries. That was actually a by-product of very intensive tax audits, which is interesting. But I think communication and understanding of how you are running the business is a key component of being favorably risk assessed by the authorities. If they understand the governance model of your company, your internal controls, they get a little more comfortable that there are reasons to be relying on you as more of a “straight and narrow” type taxpayer.

On running a global tax function

Todd Immell In your tax function at P&G, have you had to shift around the specialisms that your people are trained in to kind of take account of shifting taxes, big shifts towards indirect taxes for example? Have you had to restructure for that?

Tim McDonald Yes, we have restructured in two ways. If you went back ten years, we had a very country-centric model with almost no official specialization, and we almost exclusively focused on income tax on a country by country basis and the finance and accounting function of the company generally took care of the indirect taxes. We have since adopted a regional entrepreneurial model or principle structure, and we have formed a matrix management organization. We now have regional and country matrices and subject matter specializations (indirect taxes, transfer pricing, business model design and audit defence).

Much more recently we have continued our focus on a “where is the money?” approach. Increasingly it’s much more focused on indirect taxes, so we are forming a specialisation group within tax and we are populating it with both traditional tax people who have an expertise in indirect tax as well as finance people who are very familiar with the IT and business model.

This cross discipline staffing approach is a by-product of the supply-chain sensitive nature of indirect taxes. We are also elevating indirect tax awareness a lot through our internal training so that those involved can perform their duties with a higher level of excellence.

On tax in the boardroom

Todd Immell To wrap up Tim, do you think tax has become more, less or the same of a boardroom issue for P&G recently?

Tim McDonald I have not noticed a change. It’s been elevated and important to our board for quite a while, and we regularly present to the audit committee. They are very interested in it. We have reviewed IRS Commissioner Shulman’s remarks about the Board of Directors responsibilities for the administration and collection of income taxes, presented 19 October 2009 and are prepared to discuss it with the directors. We essentially do all of those activities currently so I think we are a little ahead of the curve in that respect.

Tim McDonald Vice President, Finance & Accounting, Global Taxes — Procter & Gamble www.pg.com

Todd ImmellTax Account Leader — Ernst & YoungTel: +41 58 286 5572 Email: [email protected]

Tim McDonald on tax in the boardroom:

“It’s [tax] been elevated and important to our board for quite a while, and we regularly present to the audit committee. They are very interested in it. We have reviewed IRS Commissioner Shulman’s remarks about the Board of Directors responsibilities … we essentially do all of those activities currently so I think we are a little ahead of the curve in that respect.”


The fifteenth conference of the parties convened under the auspices of the UN framework convention on climate change (UNFCCC) ended in Copenhagen just before Christmas. The outcome of the meeting was set out in an “accord1” signed by the parties, which, although not launching any global tax framework, will likely result in a significant increase in the use of local tax systems in order to combat climate change. The implications for CFOs and tax directors of multinational companies are significant, in terms of taxes, incentives and an overall feeling that taxation in this area is entering a period of increased fluidity and uncertainty.

Local policies to the fore

This is the first time that developing countries have agreed to put in place policies to reduce their greenhouse gas emissions. While the accord is not legally binding, it is likely that further discussions following Copenhagen will lead to individuals signatories putting in place some kind of domestic legislation to document and frame policies to be implemented to reduce their greenhouse gas (GHG) emissions.

What will this mean for the tax position of a multinational corporation? For the first time there is a clear likelihood that major developing economies such as China, India, Brazil and Indonesia will begin to use their tax systems to penalize the emission of GHGs by businesses operating in their territories. To date such taxes have been largely restricted to Europe and in particular the EU Member States.

For the tax director of a multinational with operations in developing countries, this is an important development that

requires assessment and action. Already, multinationals operating in Europe have seen evidence of such a “green tax shift.” Some companies have observed that such above-the-line taxes now represent a significant part of the tax burden of the business in Europe.

If, as seems likely, such taxes are introduced in the major developing economies, then this trend is set to accelerate. Such taxes in the EU take the form of energy or carbon taxes and this is also likely to be the pattern in developing countries. Tax directors with significant operations in Europe are already increasing their focus on environmental and other indirect taxes incurred in the operational divisions of their businesses. Leading practice for tax departments with operations in the developing world will be to follow this approach and put in place the people and processes necessary to understand the incidence of these taxes, comply in relation to their payment and ensure that all available exemptions related to these taxes are claimed on a timely basis.

International momentum stalls, for now

The accord signed in Copenhagen does not, on the face of it, seem to be linked to the previous discussions under the UNFCCC and in particular to the Kyoto Protocol. There seems to be a move away from building GHG mitigation efforts within the context of a common international agreement. This may be temporary, but if it is not, there will be consequences for the tax departments of multinational companies. The large developing economies, such as China, India and Brazil, may put in place policies to provide disincentives to GHG-intensive activities within their tax systems.

Will Bush, Climate Change & Sustainability Services Tax Leader

Tel: +44 (0)20 7951 6086 Email: [email protected]

Implications of the Copenhagen accord for CFOs and tax directors

1 http://unfccc.int/meetings/cop_15/items/5257.php


If this method is chosen in favor of national cap and trade arrangements, tax directors of multinational companies operating in these jurisdictions will need to ensure that people, processes and technology are in place to cope with new taxes with which they will need to comply, manage and plan for on an ongoing basis. This will lead to an increase in complexity for the compliance function of these companies, and tax departments should be actively assessing the implications of this eventuality.

Even if these developed countries decide to use a cap and trade mechanism rather than some form of energy or carbon tax to discourage GHG-intensive activity, it is very likely that these will be national systems as opposed to multicountry systems modeled on Kyoto and the system that is already in place within the EU.

Under this eventuality, tax directors will, of course, have to deal with national cap and trade schemes in multiple jurisdictions. While they may not be charged with administering compliance with the cap and trade regimes themselves, depending on whether this task falls to the tax department or elsewhere, they will need to consider for each jurisdiction the appropriate tax

treatment of transactions in the new emission permits which are the currency of the local cap and trade system.

This raises technical issues and also issues of uncertainty and risk. The emission permits used in such a national system will be novel, and there is likely to be a period of time where there is uncertainty about their proper tax treatment. This will lead to uncertainty and risk as tax teams in companies determine the appropriate way to include transactions in these new assets in their tax returns.

Internationally, the tax treatment of cross-border transactions in emission permits may give rise to zero or double taxation as national tax regimes deal with the transaction differently.

The efforts of the OECD to achieve a harmonized cross-border treatment may face headwinds in an environment where national cap and trade systems multiply. Cross-border transactions in emissions permits are set to become more of a tax issue as this unfolds.

In summary, therefore, tax departments are likely to face a more complex world if the accord at Copenhagen leads to fragmented

policy approaches by the richer developing countries that have now agreed to abate their GHG emissions and thus are required to bring in policies to achieve the reduction.

A clear commitment to facilitate the transfer of technology and funds to the least-developed countries

One of Copenhagen’s successes was a clear and unequivocal commitment by developed countries to facilitate the transfer of technology and cash necessary to enable the least-developed countries to move toward less GHG-intensive economies and to adapt to the consequences of climate change. This is good news for any multinational business that is involved in providing “cleantech” products or solutions or is involved in the provision of infrastructure services generally.

It is likely that from a tax policy point of view — this transfer of technology and cash will be accompanied by a range of tax measures designed to incentivize clean technology/infrastructure providers to act as agents in this delivery. Such measures may take one of two forms.


Argentina As a developing country, Argentina is not required to meet quantitative targets set by the Kyoto Protocol. However, the government has shown a growing interest in energy efficiency and renewable sources of energy as its primary means to reduce GHG emissions.

Australia Australia’s Carbon Pollution Reduction Scheme (CPRS) represents one of the biggest economic reforms of the last 30 years. It will create both risks and opportunities as businesses and the community as a whole transition to a lower carbon economy.

Brazil Brazil does not have reduction targets or a carbon cap and trade system. But the city of Sao Paulo is considering legislation that would require a GHG emissions reduction of 20% by 2020.

Canada Climate change has become one of the top concerns for Canadians. However, the significant differences in energy mix, economic interests, geography and political will across Canada have delayed the development of a robust and integrated climate change strategy. This creates a complex regulatory framework, but also provides multiple opportunities for organizations to take advantage of grants, tax incentives and infrastructure contracts.

China China has the broad targets for reducing major pollutants, but it doesn’t have the legal framework for emissions trading, nor has it committed to binding targets for emissions reduction. However, China is making aggressive investments to become one of the world’s leaders in clean and renewable energy.

European Union (EU) The EU is setting an ambitious pace for a new industrial revolution. Its goal is to reduce GHG emissions by 20%, source 20% of energy from renewable resources and achieve a 20% reduction in energy consumption through increased energy efficiency, all by 2020.

France Environmental issues are widely popular in France. That support is reflected in the country’s long-term goal of achieving a 75% reduction in GHG emissions by 2050. France is one of only 16 countries that expect to meet Kyoto Protocol targets by the 2012 deadline.

Germany Germany’s approach to climate change has been focused and aggressive. The government uses a combination of laws, taxes, subsidies and initiatives to which local and international firms in Germany must understand, respect and meet.

The world at a glance

Source: The business response to climate change — Ernst & Young — November 2009 www.ey.com/businessresponsetoclimatechange

An overview of country responses to climate change

India India has neither GHG reduction goals, nor the legal framework to enforce them. However, as the second-largest supplier of Clean Development Mechanism (CDM) carbon credits, the country may also benefit by reducing its GHG emissions.

Indonesia Environmental protection policies are not fully developed in Indonesia and enforcement is inconsistent. But greater momentum appears to be on the horizon. At the G20 Summit in September 2009, Indonesia’s president announced a carbon reduction target.

Ireland Ireland is committed to reducing carbon emissions. It has adopted a push-pull strategy — announcing ambitious energy use targets and recommending a new carbon tax.

Italy Italy is committed to reducing carbon emissions in accordance with the Kyoto Protocol through a wide range of policies and instruments.

Japan Japan is committed to combating climate change and increasing energy efficiency. Japan launched a voluntary reduction program for both companies and households in 2005 called the Team Minus Six Percent program.

However, its new government, elected in August 2009, has pledged to reduce CO2 emissions by 25% from 1990 levels by 2020 and more than 60% by 2050.

Mexico Mexico is emerging as a proponent of climate change action. The country’s national goal is to reduce emissions to 50% of 2002 levels by 2050.

Russia Russia’s size and diverse landscape offer abundant natural resources and make it a potential renewable energy powerhouse. The country’s climate change policy will include increased penalties for non-compliance as well as tax incentives for energy efficiency gains.

Saudi Arabia Saudi Arabia has not established GHG reduction goals, nor does it currently have legislation requiring reductions. However, the government is committed to responsibly serving the world’s energy needs and has announced ambitious plans to become a major exporter of solar power within the coming decade.

South Africa South Africa does not currently have binding GHG emissions reduction targets. However, it is developing a comprehensive national climate change policy framework that sees emissions peaking by 2020, plateauing for 10 years and then reducing.

South Korea Although South Korea is not legally bound by the Kyoto Protocol to cut CO2 emissions, it plans to institute policies to combat climate change. This move will make the country one of the leading proponents of reducing the global carbon footprint in East Asia.

Turkey Turkey does not have the legal framework to enforce GHG reduction targets, nor does it have climate change-related tax schemes, but it is rethinking its stance on climate change.

United Kingdom The UK is on track to almost double its existing commitment under Kyoto of reducing GHG emissions by 12.5% of 1990 levels by 2012. To achieve its goals, the UK is implementing multiple approaches, including a variety of tax incentives and levies to businesses, investment in renewables, as well as a new UK-only carbon trading scheme that will take effect in 2010.

United States The US is the only G20 nation not to ratify the Kyoto Protocol. However, with the election of Barack Obama, the US administration is changing direction. The US plans to use a mix of incentives and carbon taxes to encourage organizations to reduce their carbon footprints. In addition to federal legislation, several states have implemented their own climate change laws.

The developed country jurisdictions where the technology has been developed may provide incentives to transfer such technology to developing countries. These incentives may take the form of “patent boxes” whereby the exploitation of intellectual property destined for transfer or use in the least-developed countries will attract advantageous tax treatment. Tax directors will need to keep abreast of these developments as they arise and get involved in the decision-making processes around how and where the activities of R&D and commercialization of such cleantech products take place. The high-level role of tax, generally, will be to ensure that cleantech products are delivered at the lowest after-tax cost for the multinational provider.

The second major area to give rise to tax incentives for a multinational based in the developed world will be in the location in which the cleantech technology is to be physically hosted. Presumably the transfer of funds to the lesser-developed countries will be at least in part employed in providing local incentives to inbound cleantech providers or infrastructure developers to encourage them in their efforts of technology transfer. We already see many examples of such incentives in the form of tax holidays, reduced rates of customs duty on the import of certain equipment, enhanced VAT recovery on capital goods and accelerated depreciation. It is likely that such tax breaks will increase in number and complexity and the tax director will need to stay fully up-to-date on these developing incentives if tax is to play a full part in the transfer of clean technology solutions.

The future of the CDM remains in doubt

CDM was an arrangement under the Kyoto Protocol that allows industrialized countries with a GHG reduction commitment (known as “Annex 1 countries”2) to invest in activities that have the effect of reducing emissions in developing countries. These activities are undertaken as an alternative to more costly emission-reduction activities in their home country. The Copenhagen Accord, however, did not deal with either the future or the reform of the CDM, leaving this mechanism in some doubt given that it expires in 2012.

It has been noted above that the CDM is a major incentive in developing countries for the undertaking of clean technology projects of many forms. If this mechanism ceases to exist post-2012, it is likely that the tax systems of these jurisdictions will be used much more heavily to replace the tax credits issued under the CDM as an incentive for multinationals to engage in GHG abatement projects in local jurisdictions. Again, this eventuality will result in increased complexity for the tax director, especially with regard to the challenging nature of the tax systems in many of the developing countries in which such activities were carried out in the past.

1. Major developing economies such as China, India, Brazil and Indonesia will begin to use their tax systems to penalize the emission of GHGs by businesses operating in their territories.

2. Developed country jurisdictions where cleantech has been developed will likely provide increased incentives to companies that are involved in the business of transferring such technology to developing countries.

3. Tax incentives in the country in which cleantech technology is to be physically hosted will increase.

4. Local tax systems will be used more heavily to replace tax credits if the CDM mechanism ceases to exist after 2012.

5. Border taxes on the import of goods from regimes that do not have the same policies in relation to GHG emission abatement may increase in the future.

6. Cross-border transactions in emissions permits are set to become more of a tax issue.

Key points for CFOs and tax directors

2 http://unfccc.int/parties_and_observers/parties/annex_i/items/2774.php


A non-binding accord may mean future tax complexity

The fact that the accord reached at Copenhagen is not legally binding may lead to friction between countries that have legally binding (Kyoto) GHG emission targets and those that enter into a voluntary agreement under the accord. Much will depend on the policies adopted by the signatories to the accord in the months and years to come. However, there is a risk that if a trading block — such as the EU, which has signed up to legally binding GHG emission targets and has set in place policies to achieve these — becomes preoccupied with carbon leakage, they will introduce border taxes on the import of goods from regimes that do not have the same policies in relation to GHG emission abatement. Karel De Gucht, Europe’s trade commissioner, warned as recently as 12 January that a carbon border tax could lead to a trade war3. The idea that the EU should levy an import tax on goods from countries that do not show similar ambition in fighting global warming has long been championed by Nicolas Sarkozy, the President of France. This is an important issue for tax directors to monitor closely, as a move towards such a broader tax system will lead to significant further complexity in the management of taxes in multinational corporations.

Conclusion

The Copenhagen Accord will not, unfortunately, provide tax directors with any increased level of comfort, certainty or improved sleep. Indeed, with no clear global tax framework in place and a risk of patchwork approaches across multiple geographic jurisdictions, the climate change tax arena is one that merits increased assessment and scrutiny by the tax function in all multinational corporations. Taxes of this nature are not only forming more and more of a cost to multinational companies, but also have the potential to be a seed-bed of future tax controversy as the compliance burden increases at a time when governments all around the world thirst for revenue. Tax directors should ensure that they are crystal clear not only about exactly where in the corporation these various taxes are being managed, but that tax is a part of the decision-making process around business investment as early and as fully as possible.

3 http://www.ft.com/cms/s/0/1556f71a-ffe3-11de-ad8c-00144feabdc0.html

“The climate change tax arena is one which merits increased assessment and scrutiny by the tax function in all multinational corporations.”

Will Bush Climate Change & Sustainability Services Tax LeaderTel: +44 (0)20 7951 6086 Email: [email protected]


The new contributors to world economic growth

Tiffany Young Senior Consultant, Ernst & Young QUEST Tel: +1 202 327 7317 Email: [email protected]

Tom Neubig National Director, Ernst & Young Quantitative Economics and Statistics (QUEST) and Americas Tax Policy Services Leader Tel: +1 202 327 8817 Email: [email protected]

A dramatic change began in 2000: developing countries overall began growing significantly faster than advanced economies1. Between 1980 and 2000, advanced economies’ share of world GDP2 was relatively constant at 63–64%, while developing countries’ share of world GDP was stable at 36–37%. Since 2000, developing countries’ economies have been growing significantly faster, to a point where they accounted for 44% of world GDP in 2007, and are projected by the International Monetary Fund (IMF) to account for 51% of world GDP by 2014, as shown in Figure 1.

As we noted in a recent article about the changing location of global companies’ headquarters3, the ranks of the Fortune Global 500 companies have also changed significantly since 2000. Only 16% of the Fortune Global 500 companies were not headquartered in a G-7 country in 2000. In just nine years, that percentage had doubled to 32%.

The global markets for consumer products and investment projects is also changing rapidly as developing economies focus more on domestic consumer-led growth, have larger middle-class populations and reduce barriers to entry. Multinational companies will need to be in these fast-growing, developing economies to successfully compete for market share.

1 As defined by the International Monetary Fund (IMF), advanced economies include the following countries: Australia, Austria, Belgium, Canada, Cyprus, Czech Republic, Denmark, Finland, France, Germany, Greece, Hong Kong, Iceland, Ireland, Israel, Italy, Japan, Korea, Luxembourg, Malta, The Netherlands, New Zealand, Norway, Portugal, Singapore, Slovak Republic, Slovenia, Spain, Sweden, Switzerland, Taiwan, the United Kingdom and the United States.

2 Gross Domestic Product (GDP) is calculated using purchasing power parity (PPP) for purposes of comparing economic growth rates across countries. (IMF World Economic Outlook, p. 161.) PPP equalizes the purchasing power of different currencies in their home countries for a given basket of goods. The PPP measure is a useful measure for comparing differences in living standards between countries. GDP comparisons based on PPP can differ from GDP comparisons based on nominal exchange rates. See Deaton, Angus and Alan Heston, “Understanding PPPs and PPP-based national accounts,” National Bureau of Economic Research Working Paper #14499, November 2008. Nominal GDP in US dollars shows a similar trend with advanced economies’ share falling from 80% in 2000 to a projected 63% in 2014, while developing countries’ share increases from 20% in 2000 to a projected 37% in 2014.

3 Tom Neubig, Tiffany Young and Barbara Angus, “Landscape Changing for Headquarter Locations, Headquarter Taxation for Fortune Global 500 Companies,” Ernst & Young Tax Policy and Controversy Briefing, November 2009. www.ey.com/tpcbriefing.

*Projected estimates begin in 2008. GDP based on purchasing power parity (PPP). Source: International Monetary Fund, World Economic Outlook, October 2009.

Figure 1: Shares of world GDP: advanced and developing economies, 1980–2014

70%

60%

50%

40%

30%

20%

10%

0%

Advanced economies*

Developing economies

1980 1985 1990 1995 2000 2005 2010 2014


Table 1 shows the changing composition of world GDP for the individual countries in the G-7 (Canada, France, Germany, Italy, Japan, the United Kingdom and the United States) and the BRIC countries (Brazil, Russia, India and China). Between 1980 and 2000, the G-7 countries accounted for half of world GDP. Between 2000 and 2007, the G-7 countries’ share of world GDP declined from 49% to 43%, and is projected to fall another six percentage points to 37% by just 2014.

The BRIC countries’ share of world GDP stayed relatively constant between 15–17% from 1980 to 2000. Faster growth in China and India was offset by declines in world GDP share in Brazil and particularly Russia. After 2000, BRIC economies’ growth has accelerated significantly, particularly in China. China’s share of world GDP grew from 2% in 1980 to 7% in 2000 to 11% in 2007 and a projected 15% in 2014. India has grown from 2% in 1980, to 5% in 2007 and is projected to grow to 6% in 2014.

Table 2 shows the change in the shares of world GDP. The trends in the G-7 and BRIC countries apply to the other advanced economies and developing countries. Non-BRIC developing countries have also been growing faster than average since 2000 and are projected to continue their above-average real GDP growth rates through 2014.

*Projected estimates in 2014. Totals may not appear to add due to rounding. GDP based on PPP. Source: IMF, World Economic Outlook, Oct 2009.

Table 1: World GDP shares by G-7 and BRIC countries, 1980–2014

Country 1980 1985 1990 1995 2000 2007 2014*

Advanced economies 64% 64% 64% 64% 63% 56% 49%

Developing economies 36% 36% 36% 36% 37% 44% 51%

G-7 countries 51% 51% 51% 50% 49% 43% 37%

Canada 2% 2% 2% 2% 2% 2% 2%

France 4% 4% 4% 4% 4% 3% 3%

Germany 6% 6% 6% 6% 5% 4% 3%

Italy 4% 4% 4% 4% 3% 3% 2%

Japan 8% 8% 9% 9% 8% 7% 5%

United Kingdom 4% 4% 4% 4% 4% 3% 3%

United States 22% 23% 23% 23% 23% 21% 18%

BRIC 15% 16% 17% 16% 17% 23% 29%

Brazil 4% 3% 3% 3% 3% 3% 3%

Russia/CIS 8% 8% 8% 4% 4% 5% 5%

India 2% 2% 3% 3% 4% 5% 6%

China 2% 3% 4% 6% 7% 11% 15%

World 100% 100% 100% 100% 100% 100% 100%

*Projected estimates begin in 2008. GDP based on PPP. Source: IMF, World Economic Outlook, Oct 2009.

Table 2: Change in world GDP shares: advanced and developing economies, 1980–2014

Country/region 1980–1999 2000–2007 2008–2014*

Advanced economies -1% -7% -6%

United States 1% -2% -2%

G-7 countries (excluding US) -3% -4% -3%

Advanced economies 1% -1% -1%

Developing economies 1% 7% 6%

BRIC countries 2% 5% 5%

Developing economies (excluding BRIC)

-1% 2% 1%


Table 3 shows the ranking of the top 20 countries by GDP in 1980 and 2014. The top 20 countries account for a little more than 80% of world GDP. The G-7 countries are listed in bold, while the BRIC countries are highlighted. The IMF projects that China and India will move into second and third place, behind the United States and ahead of Japan in 2014. The combined Russia/CIS4 will fall from third to fifth place, while Brazil retains its eighth place. In 1980, six of the G-7 countries were in the top seven countries overall, while only four of the G-7 countries are forecasted to remain in the top seven in 2014.

4 Because separate data for Russia is not available before 1992, the Commonwealth of Independent States (CIS) is included with Russia for comparability. The CIS includes Armenia, Azerbaijan, Belarus, Kazakhstan, Kyrgyzstan, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine and Uzbekistan. Georgia and Mongolia, while not members of the Commonwealth of Independent States, are included by the IMF for reasons of geography and similarities in economic structure. In 2014, Russia’s share of GDP is projected to be 3.4% and the CIS’s share, including Russia, is 4.8%. In Table 4, Russia alone would rank sixth behind Germany, rather than fifth, in 2014.

Tom Neubig National Director, EY Quantitative Economics and Statistics (QUEST)and Americas Tax Policy Services Leader

Tel: +1 202 327 8817


Tiffany Young Senior Consultant, EY QUEST

Tel: +1 202 327 7317


It is important that policymakers recognize the rapidly changing composition of the world economy, particularly the major change that has occurred since 2000. Developing economies are where the largest growth opportunities have been occurring since 2000 and are projected to continue into the future. Global companies will need to be successful in the fastest-growing developing countries in order to remain successful in their domestic markets, as scale economies and product innovation are important in all markets. A competitive home country tax system will be increasingly important for successful global business competition in the fast-growing emerging markets.

*Projected estimates in 2014. Totals may not appear to add due to rounding. GDP based on PPP. Source: IMF, World Economic Outlook, October 2009. 1Top 20 only in 1980 2Top 20 only in 2014 G-7 member countries are bolded. BRIC member countries are highlighted.

Table 3: Top 20 countries ranked by share of world GDP in 1980 and 2014

Rank 1980 2014*

01 United States 22.4% United States 18.3%

02 Japan 8.3% China 15.4%

03 Russia/CIS 7.5% India 5.7%

04 Germany 6.1% Japan 5.5%

05 France 4.3% Russia/CIS4 4.8%

06 Italy 4.1% Germany 3.5%

07 United Kingdom 3.9% United Kingdom 2.9%

08 Brazil 3.6% Brazil 2.8%

09 Mexico 2.7% France 2.7%

10 Spain 2.2% Mexico 2.2%

11 Canada 2.2% Italy 2.1%

12 India 2.2% Korea 1.9%

13 China 2.0% Canada 1.7%

14 Saudi Arabia1 1.2% Spain 1.7%

15 Netherlands1 1.2% Indonesia2 1.4%

16 Poland 1.2% Turkey 1.4%

17 Australia 1.2% Iran 1.2%

18 Argentina1 1.1% Australia 1.1%

19 Turkey 0.9% Taiwan 1.1%

20 Iran 0.9% Poland 1.0%

Korea2 0.8% Saudi Arabia1 0.9%

Indonesia2 0.9% Netherlands1 0.9%

Taiwan2 0.5% Argentina1 0.8%


Vincent Oratore, Ernst & Young Financial Services Tax


Financial Transaction Levy — will 2010 be the year?

Without much doubt, tax is currently front page news more than ever before. The past 18 months have seen intense interest, scrutiny and coverage around issues such as tax havens and perceived tax abuse, significantly increased tax enforcement and audit activity by tax administrations around the world and vigorous debate around the US international tax proposals. More recently, the baton looks to have been passed on to increased interest and political activity around the taxation of the financial services industry, most notably banks. This includes both short-term, one-off taxes on banker’s bonuses and, more generally, in various formulations of a Financial Transaction Levy (FTL) for various purposes. These taxes seek to pay back funds spent on the banking rescue of 2009, but also to provide some form of super-insurance fund to protect against future events of a similar nature. These discussions have tended to be lumped together in the media as “Tobin Taxes,” somewhat erroneously given the original focus of James Tobin1 on the developing of a taxation mechanism, which was designed to reduce currency fluctuations.

Probably the most well-known multi-jurisdictional FTL initiative is that of the G20 to create a resolution/insurance fund through an international financial transactions tax. A Taskforce on International Financial Transactions for Development (TIFTD) is reviewing a currency transaction levy and a solidarity surcharge for international millennium development goals. The TIFTD is due to report in Spring 2010 for the consideration of G20 ministers. While the TIFTD formulate their recommendations, however, many

countries are pressing ahead with unilateral measures of many kinds, of both short-term (windfall) and long-term (levy) types. The question of whether such unilateral measures will negate or impede any future global effort to design and implement an FTL remains to be answered.

That said, the recent Davos meeting showed that many banking luminaries are not adverse to the idea of an FTL, with Bob Diamond, Barclays PLC president, telling the Financial Times2, “I think every G20 country would like to have an insurance scheme that would help cover the cost of any future bank failure. A coordinated global system is preferable to an unlevel playing field.” Mr. Diamond’s comments were echoed by Josef Ackermann, CEO of Deutsche Bank, who advocated that the implementation of an FTL would most likely succeed if it started with a European approach, a sentiment that seems to be supported by many who are following this debate.

FTL background

It is said that an early form of international FTL was imposed by the military order of the Knights of the Temple of Solomon in Jerusalem. Tax authorities around the world continue to strive for powers of enforcement similar to that order. More recently, John Maynard Keynes suggested, in 1936, that a transaction tax should be levied on dealings in Wall Street. He thought that excessive speculation would increase volatility, with a concern that such speculation could become dominant if left uncontrolled.

“A Taskforce on International Financial Transactions for Development (TIFTD) is reviewing a currency transaction levy and a solidarity surcharge for international millennium development goals ... and is due to report in Spring 2010.”

1 No relation to Jim Tobin, Ernst & Young’s Global Director of International Tax Services 2 http://www.ft.com/cms/s/0/82f4444a-0d3e-11df-af79-00144feabdc0.html


As noted, probably the best known FTL, however, was proposed by James Tobin in 1973. The Tobin Tax was proposed in the wake of the collapse of the system of fixed exchange rates set up by the Bretton Woods Agreement. Tobin proposed to reduce volatility and speculation against a currency (which could undermine a sufficiently weak economy) by imposing a small (in percentage terms) tax on each currency transaction. It would be small so that it would not affect genuine economic activity but would be sufficiently large to make uneconomic short-term speculative transactions.

In 1984 Sweden introduced a type of Tobin Tax on Swedish stocks and derivatives and in 1989 on bonds. This drove domestic investors offshore and foreign investors to trade through London, and in due course, the tax was repealed. However, many countries have domestic FTLs; these range from relatively recent FTLs in Argentina, Colombia and Brazil to “stamp duty” in the United Kingdom. If the environment and the rate of tax is correct, domestic FTLs can be sustained, although it is very difficult to know to what extent this has caused distortions in economic activity.

The building blocks of an FTL

Since the 1970’s there have been a series of themes that have been periodically rehearsed in the context of an FTL:

• The purpose

• Enforcement procedures

• Whether the FTL is domestic or international

• Which financial transactions the TFL covers

• Rates

• The need to avoid distortion

Purpose

The primary purpose is, of course, to generate revenue. Both the TIFTD (which has its roots in the 2004 UN Declaration on Action Against Hunger and Poverty) and the G20 initiative are focused primarily on generating revenue albeit for quite different causes. This driver, however, is fundamentally different from James Tobin’s policy imperative and means that the target of the tax and its calibration are quite different. Essentially, if the policy is to raise revenue the only limit on the rate is the avoidance of economic distortion.

A secondary purpose of an FTL may be to reduce speculation. Intuitively, speculation seems to be a bad thing for markets. However, it is arguable that speculators act to stabilize markets through rational arbitrage. When prices rise above their fundamental fair value, speculators will sell and drive the price back to an equilibrium level and vice versa when prices are below the equilibrium level. The opposite is also arguable, that speculators move the market away from equilibrium. Evidence, of course, can be found to support both arguments.

This uncertainty was addressed by Spahn3 in 1996 in the context of currency transactions. He proposed that in normal market conditions there would be no charge or a minimal charge but when the exchange rate moved outside of a “normal market collar,” a high rate of tax would apply thus discouraging speculation.

It is clear from empirical evidence that Tobin was correct to fear arbitrageurs taking a position against a currency and effectively undermining an entire economy. An FTL set at the right rate in the right conditions could be effective to deter that kind of behavior. While speculation has been the target of some FTLs, an FTL can be imposed simply to slow down a particular activity, which is of concern to policy makers.

Enforcement procedures

One of the most common criticisms of FTLs is the difficulty of enforcing them. The Swedish example is often cited as an example of the mobility of financial transactions. However, there are many examples of jurisdictions with FTLs where there has been no evidence that activity has migrated by reason of the FTL — UK stamp duty on shares being a notable long-standing levy. The TIFTD and the G20 initiative are both aimed at an international FTL which many view as being the only way to effectively impose an FTL.

The problem with simply imposing a tax relates to impossibility of collection on offshore transactions and migration of transactions to jurisdictions not affected by the charge. Collection of the tax at the level of the clearance system is attractive. In the context of the taxation of currency transactions, continuous limited settlement systems are a way to avoid settlement risk in the foreign exchange (FX) market. The CLS Bank settles over 75% of all FX transactions, and an FTL could be collected as part of the CLS system.

3 The Tobin Tax and Exchange Rate Stability — Paul B. Spahn, 1996

“We were all in agreement that it had to be a universal taxation or universal levy or instrument to avoid the risk of arbitrage.”

French Economy Minister Christine Lagarde —

G7 meeting, Canada, 6 February 2010


This was the principal method of enforcement envisaged by the report proposing a stamp duty on sterling FX transactions, prepared for Stamp out Poverty in 2005.

A third method, namely making the contract unenforceable in a jurisdiction, would work only if the transaction contract could not be enforced in any of the countries in which a judgment would be effective and respected elsewhere.

Whether the FTL is domestic or international

The current focus is on international FTLs, primarily because of the amount required to be raised. Indeed — and as noted in a recent UK Treasury paper — the migration of business risk on a unilateral FTL is too great to countenance for countries with a substantial, fragile and mobile financial sector.

Which financial transactions the TFL covers

Currently domestic FTLs include taxes on transfers of bonds, shares and futures. The transaction which is almost the default assumption for an international FTL is foreign exchange. This is for a variety of reasons; with regard to size, a small, non-distortive, percentage tax would yield an enormous amount of money if applied to global FX; historically, the Tobin Tax and many of its descendants were based on currency transactions for reasons which have not been fully proven and which are not the focus of today’s policy imperatives; and finally, in terms of enforcement, the CLS Bank provides a perfect collection mechanism for an FTL on currency transactions.

However, in terms of behavior modification, there are other financial transactions which may be of more concern to regulators. For example, credit derivatives, in cash or synthetic form, or in other formats such as re-insurance.

Three ways to impose and enforce an FTL:

• Unilateral or multi-lateral imposition of a tax charge

• Collection of the FTL at the level of the system clearing the relevant financial transactions

• Making financial transaction contracts unenforceable unless the tax is paid

In December 2009, the UK Treasury published a paper on Risk, reward and responsibility: The financial sector and society4. Section 4 of the paper discusses the possibility of a financial transaction tax. The thinking in the paper is known to be shared by a number of other G20 members, in particular the principle that the financial sector should make a fair contribution to society taking into account the risks which it takes.

The paper stipulates four necessary criteria for the tax:

• Implementation at a global level: Given the relative size and fragility of the UK financial sector, it is not surprising that the UK government favors global action. Unilateral action by the UK would carry a significant risk of migration of the relevant class of transaction out of the UK. The paper envisages participation by all major financial centers and that globalization is necessary to keep abreast of market developments that might facilitate avoidance of the charge.

• Minimal distortionary impact: The paper recognizes the importance of careful calibration of the rate and targeting of tax as well as the potential benefits for deferral of introduction of the charge until the capital markets are less fragile. It also recognizes that the goals of raising revenue and modifying behavior (in the context of off-balance sheet transactions/credit derivatives) may be inconsistent. For example, to raise revenue, a tax on FX, globally implemented and collected through CLS Bank and SWIFT, would appear feasible. It will be more difficult to collect tax on credit derivative transactions, which may be an activity which the authorities wish to monitor and slow down.

• Ensure financial stability: The paper makes the point that a great deal of effort has been made to recapitalize the financial sector and that an FTL should not materially impact this capitalization and should be implemented in concert with all of the other steps being taken properly to capitalize the banks.

• Be fair and measured: Again, an FTL should not materially impact this capitalization and should be implemented in concert with all of the other steps being taken properly to capitalize the banks.

The paper also comments on the need to balance the revenue generating effect of the tax with a need not to dampen economic activity. The paper is further concerned with building as broad a tax base as possible to prevent avoidance and with determining a means for allocation of revenue.

The UK Treasury paper on the financial sector and society

4 http://www.hm-treasury.gov.uk/fin_financialsector_society.htm


Rates

In 2008, Rodney Schmidt prepared a paper on The Currency Transaction Tax: Rate and Revenue Estimates. In contra-distinction to the Tobin Tax, it was not intended to deter speculation or slow capital flows but merely to raise revenue. It assumed collection through the CLS Bank and the SWIFT system. A currency transaction tax of half a basis point on the US$, the Euro, Yen and Sterling would yield US$33.4 billion per annum, according to the estimates, with the rate set at the inflection point which maximizes revenue before creating distortions such as reduced volume and avoidance.

An FTL that is designed to modify behavior is more difficult to calibrate. This is particularly so in the context of an international FTL where there is no empirical evidence on the impact of a charge. Particularly in the current fragile economic environment, a rate which is even only marginally too high could stop instead of slowing economic activity in a financial sector. If it were decided to impose an FTL to modify behavior, the lead of the Basel regulators could be followed by imposing the charge at increasing rates over a transitional period.

The need to avoid distortion

As noted above in relation to setting a suitable rate, it is very easy, particularly in current capital markets, to impose a relatively minor charge which has a massive impact on economic activity. The primary and secondary impact of an FTL will need to be carefully studied as the cumulative impact of friction on capital market transactions has been brought into focus by the credit crunch.

The term “distortion” encapsulates a number of concepts:

• Unexpected reduction in volume of the targeted financial transaction with damaging effects on the economy

• Unexpected incidence of taxation falling not on the anticipated taxpayer base but elsewhere

• Avoidance of the charge by migration of the financial institutions or of the transactions. For example, if the rate were high enough, it may be worth financial institutions setting up settlement systems in competition to CLS Bank and SWIFT. To accomplish the same legal benefits would be costly but a cost/benefit analysis would be done

• As noted above, the reduction in short-term trading volume may actually have a beneficial effect on deterring speculation which may reduce economic distortion


National approaches emerge

As the focus of media and political activity at the end of 2009 and beginning of 2010 has centered more closely upon the financial services industry in general and banks in particular, a number of countries have already announced or implemented a series of national tax measures. Some measures are designed to claw back all or part of the costs which were incurred in the financial bail outs of 2009 while some are more specifically designed to change the compensation behavior of banks who plan to pay out significant bonuses in the same year in which they received significant public financial support.

Focus on taxation of bank bonuses: UK and France

In December 2009, both the UK and France announced — within 24 hours of one another — very similar measures designed to claw back part of the financial services rescue costs via one-off taxation of banker’s bonuses. In the UK Pre-budget report on 9 December 2009, a one-off 50% tax was announced, payable on bonuses in excess of £25,000. The tax will cover bonuses awarded between 9 December 2009 and 5 April next year. France followed with an announcement of similar measures within 24 hours, announcing on 10 December 2009 a one-off 50% tax on bonus pay-outs for 2009 above €27,000 (just under £25,000 at current exchange rates). The taxes, in both cases, are to be paid by banks and not the bank employees, and although the total amount they will raise in each case are unknown at this point, estimates of £550 million in the UK and around €360 million in France have been posited in the media5.

President Obama proposes fee on large financial firms to recover costs of financial rescue

The Obama Administration on 14 January 2010 proposed a new fee on a broad range of financial institutions with more than $50 billion in consolidated assets, aimed at recovering funds devoted to the financial rescue program (TARP). Following the president’s announcement, the Treasury Department indicated that the fee would be deductible for federal income tax purposes.

The new Financial Crisis Responsibility Fee6 was included in the administration’s fiscal year 2011 budget proposals released on 1st February. The administration announced its rationale for the fee, and also provided limited details on how the fee will be calculated and to whom it applies. Few additional details were

included in the budget release. The president’s proposal is a legislative proposal, so the ultimate determination of whether and what will be imposed is subject to the congressional legislative process. Importantly, members of Congress have introduced other proposals aimed at financial institutions, including transaction taxes and taxes on bonus pools.

The fee, which is proposed to take effect on 30 June 2010 would be assessed at approximately 15 basis points (0.15%) of a firm’s covered liabilities per year. The proposal is expected to raise $90 billion over the next 10 years, and $117 billion over about 12 years, though Obama said the fee would be in place “as long as it takes to raise the full amount necessary to cover all taxpayer losses.” The Treasury also indicated that the fee will be deductible.

The 12-year revenue figure parallels the administration’s latest estimates of the cost of the TARP rescue fund, which was capitalized with $700 billion from the Treasury but is now expected to cost taxpayers $117 billion, after repayments by several large firms (according to administration projections). While firms that have paid back TARP infusions have done so with interest and dividends, repaying more than they received, the shortfall is based on the assumption that some TARP capital infusions will never be recovered.

The fee would be collected by the IRS, based on assessments of covered liabilities ultimately calculated with the assistance of banking regulators. According to an administration fact sheet, the fee would apply to firms that were bank holding companies, thrift holding companies and insured depositories (as well as insurance or other companies that owned insured depositories as of 14 January 2010) and broker-dealers. For any institution, the fee would be calculated to exclude tier one capital and FDIC-assessed deposits held by the company, and adjusted for liabilities due to insurance policies covered by state guarantee funds. The administration estimated that more than 60% of revenues generated “would likely be paid by the 10 largest financial institutions” in the United States.

Administration documents also said the fee would apply to US subsidiaries of foreign firms. Operations of such subsidiaries “would be consolidated for the purposes of the $50 billion threshold and administration of the fee. For those firms headquartered in the United States, the fee would cover all liabilities globally.”

5 http://www.ft.com/cms/s/0/cc00f558-ff69-11de-8f53-00144feabdc0.html 6 http://www.treas.gov/press/releases/tg506.htm


7 http://www.ft.com/cms/s/0/94e4067a-1452-11df-8847-00144feab49a.html

Vincent Oratore Ernst & Young Financial Services Tax, EMEIA FS Tax Policy LeaderTel: +44 20 795 14504Email: [email protected]

Conclusion

The discussion of FTLs is part of the wider debate on financial stability and comes at a time where there is widespread activity at the national level and unprecedented interest from politicians, the media and from the public.

At this stage, it is impossible to assess whether the current focus and measures being implemented nationally will assuage perception to a degree where an FTL is no longer considered necessary, attractive or achievable. Clearly, the US administration has decided to pursue their chosen route because — compared to the complexity of implementing a global FTL — it is quick and efficient and can be imposed unilaterally. They may also have chosen, based upon a collective view that a global FTL is unenforceable. Interestingly, Mervyn King, Governor of the Bank of England, when addressing the Treasury Select Committee as recently as 26 January said “I don’t know anyone on the international circuit who’s enthusiastic about it ... of all the measures being considered, the Tobin Tax is probably at the bottom of the list.” This would seem to contradict with the communiqué issued at the conclusion of the recent G7 meeting in Canada, where, according to the Financial Times on 08 February 2010: “Finance ministers from the world’s most advanced nations have begun to coalesce around the idea of imposing forward-looking levies on banks to help insure the global economy against financial crises, officials said after a Group of Seven meeting in Canada.7”

If a wider FTL is to be considered, the extensive changes to regulation of the capital of financial institutions and their liquidity will need to be carefully assessed when looking at the rates and incidence of the tax. If governments wish to raise substantial revenue and modify potentially problematic behavior through taxation, separate taxes may be necessary. Given the context of the consideration of the FTL and the political uncertainty, it is hard to know if a consensus will be reached, but it is possible that 2010 may be the year in which a workable FTL is formulated. At a minimum, the IMF and the G20 will report on the FTL preliminarily in April 2010 and finally in June 2010, while the TIFTD is due to report in Spring 2010 for the consideration of ministers.


The year 2010 looks set to be a challenging time for indirect taxes. January has already seen a large number of changes in Value Added Tax (VAT), Goods and Services Tax (GST), excise duties, customs duties and environmental taxes around the world. And many more changes are anticipated as the year progresses.

These developments range from changes in VAT and excise rates to major indirect tax system reforms. Indirect taxes are also increasingly being linked to “green” policies aimed at improving the environment. These trends are driving a dramatic rise in the importance of indirect taxes to governments.

Philip Robinson, Global Director, Indirect Tax


Indirect Tax in 2010

European Union (Austria, Belgium, Bulgaria, Cyprus, the Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, The Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden and the United Kingdom.)

Spain The VAT rate will increase to 18% on 1 July 2010.

Czech Republic The standard VAT rate increased to 20% on 1 January 2010.

Ireland The standard rate of VAT decreased to 21% on 1 January 2010.

India A major indirect tax reform is expected in 2010. The new GST will replace a host of indirect taxes that currently apply at the federal and state levels. But its introduction may be delayed.

Pakistan A draft VAT Act anticipates major changes, including an expansion to the scope of input tax recovery, “reverse charge” taxation for imported services and fewer exemptions.

China A major revision to the VAT system is planned for 2013. The draft VAT law for the reform is expected in 2010.

Malaysia A major indirect tax reform is proposed for 2011. Details of the reform are expected in 2010.

New Zealand Amendments apply to the Climate Change Act, including extending zero-rating to certain emissions units.

Indonesia A long-awaited major reform of the VAT system is planned to come into effect on 1 April 2010.

Switzerland A major reform of the Swiss VAT system came into force on 1 January 2010. Reforms include changes to the place of supply rules for supplies of gas and electricity and electronic services.

Finland The standard rate will increase to 23% on 1 July 2010.

Israel Standard rate of VAT reduced to 16% on 1 January 2010.

European Union The EU VAT Package is the most significant development in EU VAT in many years. New rules affect all businesses that trade internationally in services, whether as a supplier or purchaser.

UK The standard VAT rate returned to 17.5% on 1 January 2010.

Mexico A new tax against poverty (TAP) is proposed in the form of a general consumption tax of 2%, to be charged on top of the 15% VAT.

Canada A Harmonized Sales Tax (HST) is planned for 1 July 2010, when the provinces of Ontario and British Columbia replace their existing provincial sales tax systems and harmonize them with the federal GST.


1 From income to consumption — the shifting tax balance. Ernst & Young November 2009. www.ey.com/tpcbriefing 2 www.ey.com/stimulus 3 http://www.ey.com/vatpackage 4 For more information see the article “Special focus: India” in the November 2009 edition of the Ernst & Young Tax Policy and Controversy Quarterly Briefing, which is available at www.ey.com/tpcbriefing

Economy as a driver of policy

The state of the global economy continues to be a major factor driving indirect tax policy development, with the gradual withdrawal and phasing out of fiscal stimulus measures in many countries being the source of 2010’s proposed VAT changes.

In addition, many governments are now looking towards tackling fiscal deficits which have arisen from the economic downturn and the resulting reduction in tax receipts. Increasingly, they are looking to taxes on consumption1 to help stabilize revenue collections in an environment where corporate profits are down.

Increases in VAT

The year 2010 sees an increase in VAT rates in a number of jurisdictions. In the past few years, many countries sought to maintain demand by reducing the costs of goods and services through temporarily lowering indirect taxes. One common action was to reduce the VAT rate, either the headline rate, the reduced rate (in the cases of EU Member States) or for certain targeted products, as we described in our May 2009 guide to fiscal stimulus packages around the world2.

Another prevalent approach was to suspend or defer planned VAT increases and 2010 sees this trend unwinding, in many cases. VAT increases took effect on 1 January in the Czech Republic and the United Kingdom, where the rate had been temporarily reduced by 2.5% in December 2008 as part of fiscal stimulus measures.

VAT rate increases have been announced for July 2010 in Finland and Spain, and Switzerland is also planning to increase its rates, although the increases have been deferred to 2011. Mexico is also considering adding a 2% tax on poverty to its 15% VAT base. As budget deficits continue to bite, other countries may follow suit. Only the Republic of Ireland has recently bucked the upward rate trend by reducing its VAT rate by 0.5% with effect from 1 January 2010, bringing the standard rate back to 21%, after it was increased in December 2008 in response to the financial crisis. Interestingly, Ireland also reaffirmed its commitment to keeping the corporate income tax rate at 12.5%, cementing their reputation for tax competition, but also confirming the need to look elsewhere for tax revenue.

Indirect tax reform in 2010

Tax reform also seems to be high on the agenda of governments and tax administrations. Around the world, many countries have introduced or are anticipating major reforms in their VAT/GST systems in the next couple of years, including China, Egypt, Indonesia, Malaysia and Pakistan. Even well-established VAT/GST systems are not immune to significant changes. The European Union (EU) and Switzerland, for example, have both introduced major VAT changes on 1 January 2010 that have a significant impact on the VAT treatment of a range of international services3.

Reforms are also anticipated in Canada and India, where in both cases we see a move away from sub-national indirect taxes towards a more harmonized national system. The proposed Indian reforms4 of a dual-structure GST represent one of the largest ever indirect tax changes in Indian history and its potential introduction is an incredible challenge. Businesses are advised to commence an immediate review of the potential impacts and also to engage in a dialogue with the authorities on its design, particularly in light of the consultation process which has been launched by the Indian authorities.

Implications for multinationals

In each case, domestic and international taxpayers will be affected by the adoption of new indirect tax rules and accounting procedures. In the coming year, many businesses will need to adapt not only their indirect tax reporting systems but also their tax strategies to take into account major developments in a number of taxes and a number of jurisdictions.

On the plus side, Switzerland has introduced a very welcome measure related to evidence/documentation which reduces the compliance risk for taxpayers. A number of countries, such as Latvia, Finland, Israel and the UK, are also using new technology to change the way that VAT returns are submitted or payments are made. For some taxpayers, these changes will be welcome, although they may create difficulties for other taxpayers. But for global companies, the real issue is the number, complexity and frequency of indirect tax changes around the world.

The pace and amount of change — even where it involves simplification — greatly increases the level of complexity they face and therefore increases their level of tax risk and the potential of future tax controversy.

Global businesses need to be aware of these trends and how these significant developments in indirect taxes have an impact on each and every stage of the tax life cycle — compliance, planning, tax accounting and controversy. More and more often, we are hearing the message from tax directors that indirect taxes are rising up the tax function agenda faster than ever before, and that more investment and resources are being directed at their management. These are sensible moves in challenging times.

A summary of VAT, GST, sales taxes, customs and excise changes in 2010 is available at www.ey.com/Indirecttaxin2010.

“The use of VAT rate decreases as a core component of fiscal stimulus in 2009 reverses in 2010 with widespread rate increases in many countries.”

Philip Robinson Global Director, Indirect TaxTel: +41 58 289 3196Email: [email protected]

“In the coming year, many businesses will need to adapt not only their indirect tax reporting systems but also their tax strategies to take into account major developments in a number of taxes and a number of jurisdictions.”


China strengthens tax collection on non-residents’ equity sales

On 15 December 2009, the China State Administration of Taxation (SAT) announced Circular 698, which provides further guidance on Corporate Income Tax (CIT) administration on gains from equity sales derived by non-residents.

The term “gains from equity sales” refers to income derived from transferring equity interests in Chinese-resident companies by non-residents, excluding income derived from the buying and selling of China company stocks on public stock exchanges. Circular 698 stipulates the non-residents’ obligation to report and the Chinese tax authorities’ jurisdiction over such gains, clarifies how gains are to be computed, and also imposes an obligation on non-residents to supply information and documents regarding indirect sales.

If a non-resident investor indirectly disposes of a Chinese resident company’s equity interests by selling the shares of an intermediate holding company located in a jurisdiction where the effective tax rate is lower than 12.5%, or that exempts offshore income from tax, Circular 698 requires the seller to submit information and documents to the tax authority within 30 days of the conclusion of the equity transfer agreement. If the existence of this intermediate holding company is found to have no commercial purpose except the avoidance of tax liabilities, Circular 698 asserts the Chinese tax authorities’ rights to invoke the general anti-avoidance rules to disregard the intermediate holding company.

Background

Circular 698 is a further initiative by the SAT to step up tax administration and collection on non-residents. It confirms what had been widely anticipated among foreign investors and tax practitioners:

1. The previous practice (which allowed the exclusion of retained earnings and reserves from the sales proceeds in the calculation of gains arising from equity sales by non-resident investors) will no longer apply as of 1 January 2008 (i.e., retroactively).

2. The Chinese tax authorities’ previous attempts at the local level to invoke anti-avoidance (look-through) rules on indirect sales of Chinese resident companies’ shares will develop into a nationwide exercise.

3. Substance and commercial reasons for the establishment of intermediate holding companies are crucial for non-resident investors to enjoy reduced withholding tax rate benefits under double tax agreements with China.

Circular 698 also shows that the Chinese tax authorities are shifting from a reactive stance to a proactive one in an attempt to tax indirect sales of equity stakes in Chinese resident companies. The circular, in addition to asserting the Chinese tax authorities’ right to tax such gains, imposes a self-reporting obligation on a non-resident seller in the case of indirect equity sales through the disposal of an intermediate holding company located in a low tax jurisdiction or tax haven.

Country focus

ChinaBecky Lai, Ernst & Young, Tax Policy Services

Tel: +86 10 58152830 Email: [email protected]

Owen Chan, Ernst & Young, Tax Controversy Services

Tel: +852 2629 3388 Email: [email protected]

Special focus: China strengthens tax collection on non-residents’ equity sales


Becky Lai Ernst & Young, Tax Policy ServicesTel: +86 10 58152830Email: [email protected]

Owen Chan Ernst & Young, Tax Controversy ServicesTel: +852 2629 3388Email: [email protected]

This means the Chinese tax authorities are prepared to examine the commercial realism of each and every such indirect equity sale and, as a result, the intermediate holding company may be disregarded.

Implications

Given the retroactive effect from 1 January 2008, there is need to consider restructuring and merger and acquisition activities that took place during 2008 and 2009 in the absence of Circular 698. Technically speaking, with such a retroactive application of Circular 698, a reporting obligation arises for those past transactions involving indirect disposal of Chinese resident companies. Foreign investors engaging in such transactions should immediately examine and, if applicable, rectify their reporting obligations and previous tax treatments.

Current intermediate holding companies located in low tax jurisdictions or tax havens should be reviewed for substance and commercial realism, as they will be subject to strict scrutiny in China. In addition, Circular 698 clarifies that the Chinese resident company’s retained earnings and reserve funds attributable to the equity transferred cannot be deducted from the sales consideration (whereas they were deductible under the old China income tax law scheme). Companies undergoing restructuring or divestment may consider distributing the retained earnings of a Chinese resident company beforehand to avoid unnecessarily increasing the taxable capital gains as computed under Circular 698.

Tax policy drivers

China’s economy has not been immune to the global financial crisis, given its considerable reliance on international trade and foreign direct investment (FDI) for economic growth. To spur domestic demand, China is increasing government spending and announcing various industry-wide stimulus plans. In order to fuel the SAT’s stimulus plans, Chinese tax authorities aimed to deliver a 10% growth in tax revenue for 2009. As well as implementing nationwide tax audits, strengthening the monitoring of large companies and enforcing general anti-avoidance measures, China SAT has also turned its focus on non-residents. In 2009, we have seen more than ten circulars issued specifically on enforcing tax collection from non-residents by the SAT. Circular 698 is a further example and is unlikely to be the last.


French Parliament enacts Finance Bill for 2010 and Amended Finance Bill for 2009

The French Finance Bill for 2010 and the Amended Finance Bill for 2009 were enacted at the end of December 2009 by the French Parliament. Many of the changes have implications for multinational companies.

Repeal of the French domestic interest withholding tax

The Amended Finance Bill for 2009 abolished the French domestic withholding tax on interest paid by French resident entities to non-French residents, except if the interest is paid to “uncooperative” countries (see below). This new domestic exemption applies to interest paid after 1 March 2010. As a consequence, for interest paid after 1 March 2010, the so-called Article 131 quarter exemption — which notably requires that a loan agreement be concluded and that cash be transferred to the French borrower — will not be of any benefit, except for interest paid to uncooperative countries and related to contracts concluded before 1 March 2010.

“Uncooperative countries”

The Amended Finance Bill for 2009 has introduced a series of anti-abuse provisions that apply to payments made to, or received from, income realized in jurisdictions that are considered “uncooperative countries,” as per a list to be published annually by the French tax authorities. The list for 2010 should be released soon by the French Tax Authorities. For 2010, the jurisdictions that are considered “uncooperative countries” are all non-EU member states, the tax systems of which have been scrutinized by the OECD, and that have not entered into an administrative assistance agreement with France or at least 12 other jurisdictions.

Focus on “Uncooperative countries”

Withholding tax on passive income paid to uncooperative countries

Dividends, interest, royalties and remunerations for services paid to uncooperative countries as of 1 March 2010 are subject to a 50% withholding tax, while under the former applicable French domestic regulations (and absent any treaty protection), they were generally subject to a 25%, 18% or 33 % withholding tax, respectively. However, for interest and remunerations for services paid by a French debtor, the 50% withholding tax rate can however be avoided, where the French-resident debtor can demonstrate that the transaction is real and that its main purpose or effect is not tax avoidance.

Interest paid to uncooperative countries may still be withholding tax-exempt if it relates to contracts entered into before 1 March 2010 and satisfies the qualifying conditions for the Article 131 quarter exemption (i.e., conclusion of a loan agreement before cash is transferred to the French borrower).

Tax levy on capital gains realized by entities or individuals domiciled, established or constituted in uncooperative countries

Capital gains realized by entities or individuals domiciled, established or constituted in uncooperative countries on the sale of interest in French companies, in companies that are predominantly French real estate companies or in real estate property, are subject to a 50% tax levy. This provision will apply to gains realized on or after 1 March 2010.

Capital gains/losses on the sale of shares in companies established in uncooperative countries

Capital gains realized by a French corporation on the sale of shares in companies established in uncooperative countries will no longer benefit from the French 95% participation exemption regime and are therefore fully taxable. Capital losses upon the sale of such shares may only be offset against capital gains of the same nature and not against ordinary profits. This provision will apply to capital gains/losses realized during fiscal years beginning on or after 1 January 2011.

Country focus

FranceSpecial focus: French Parliament enacts Finance Bill for 2010 and Amended Finance Bill for 2009

Charles Menard, Ernst & Young société d’avocats

Tel: +33 (0) 1 55 61 15 57 Email: [email protected]


New transfer pricing documentation requirements

For fiscal years after 1 January 2010, contemporaneous transfer pricing documentation is required from French entities, the revenue or gross assets of which are equal to, or exceed, €400m, or from French entities affiliated with an entity that exceeds that same threshold.

This documentation includes general information about the group to which the French entity belongs (e.g., description of the structure, activities, functions, assets and risks, as well as a general description of the group’s transfer pricing policy) and specific information about the French audited company (e.g., description of the activities and transactions, as well as a presentation of the applied transfer pricing method, including a functional analysis).

These documentation requirements are even more stringent for transactions entered into with affiliated entities established in uncooperative countries for which, in addition to the above documentation, a balance sheet and a profit and loss account must also be provided. Failure to provide this documentation upon a tax audit, and after a 30-day period following a formal request delivered by the French Tax Authorities, may result in penalties of up to 5% of the amount of the transferred profits.

Modifications to the French tax consolidation regime

In the so-called Papillon case (case C-418/07), the European Court of Justice (ECJ) ruled on 27 November 2008 that the French tax consolidation regime was incompatible with the EU Freedom of Establishment in that it prohibited the consolidation of lower-tier French subsidiaries held through subsidiaries established in another EU member state. The Amended Finance Bill for 2009 secures EU approval of the French tax consolidation regime by allowing the interposition of entities or branches established in another EU member state between French members of a French tax consolidated group.

This new definition expanding the entities that can be part of a French tax consolidated group is applicable to fiscal years ending on or after 31 December 2009. Also, French taxpayers may claim the benefit of this new definition for fiscal years ending between 1 September 2004 and 30 December 2009, and request a refund of overpaid corporate income tax if applicable. The Amended Finance Bill for 2009 also specifies the tax treatment of certain transactions and flows between the French tax consolidated entities and the interposed EU entities or branches, such as asset sales, debt waivers, dividends and interest payments.

Focus on “Uncooperative countries” (cont’d.)

Interest, royalties and other remuneration paid to recipients established in uncooperative countries

Interest (other than that related to loans entered into before 1 March 2010), royalties and other remuneration paid by French residents to recipients established in uncooperative countries will not be tax deductible unless the French resident debtors can demonstrate that the transaction is real and conducted at arm’s length, and that its main purpose or effect is not tax avoidance. This provision applies to interest, royalties and other remuneration paid or accrued during fiscal years beginning on or after 1 January 2011.

The expenses that correspond to such payments and that are deducted for corporate income tax purposes by French debtors must be reported on a specific form to be attached to the corporate income tax return.

Dividends paid by a corporation established in an uncooperative country

Dividends received by a French parent from a subsidiary established in an uncooperative country can no longer benefit from the French 95% dividend participation exemption and are therefore fully taxable. This provision applies to dividend distributions received during fiscal years beginning on, or after 1 January 2011.

Controlled foreign corporation (CFC) rules are reinforced if the subsidiary is located in an uncooperative country

Article 209 B of the French tax code (French CFC rules) provides a set of exemptions allowing for the avoidance of immediate taxation of profits realized by a CFC. One of these exemptions applies to profits realized by entities or branches established in a non-EU member state, provided that the profits are derived from a commercial or industrial activity effectively performed in the country of establishment of the CFC and, if the proportion of those profits that is derived from certain passive income exceeds specific thresholds, provided that the French taxpayer can establish that the main effect of the structure is not to transfer profits to a privileged tax jurisdiction.

The main change introduced in the French CFC rules, effective since 1 January 2010, is that to benefit from the above mentioned exemption, if the CFC is established in an uncooperative country, the French taxpayer also has to establish that (i) profits are derived from a commercial or industrial activity effectively performed in the country of establishment of the CFC and that (ii) the specific passive income thresholds are not exceeded.

Alternatively, the French taxpayer may seek an exemption by providing to the French Tax Authorities all necessary information to assess the effectiveness of the commercial or industrial activity carried out and the specific passive income thresholds, and by justifying that the activities carried out by the foreign entity or branch established in an uncooperative country do not have tax avoidance as a principal object or effect.

In addition, dividend, interest and royalty withholding taxes borne by the CFC can be credited by the French company only if the dividends, interest or royalties are paid by a French company or a company established in a country that has signed a tax treaty with France and that it is not an uncooperative country.


As an example, under the French tax consolidation regime, the 5% taxable portion of the dividend received by a tax consolidated company from another tax consolidated company is deductible from the consolidated income except if it relates to dividends paid during the first year of inclusion of the distributing entity in a tax consolidated group. The benefit of this rule is extended to dividends paid by an interposed EU entity to a French parent provided that those dividends correspond to dividends initially received from a French tax consolidated company and that both the latter and the French parent have been included in the tax group for more than one fiscal year.

Anticipated refund of the research and development tax credit

As a general principle, the research and development (R&D) tax credit can be used to offset the income tax liability of the year during which the R&D expenses have been incurred and the following three years; any unused portion of the credit is then refunded by the French treasury. The Amended Finance Bill for 2008 allowed French companies to claim in 2009 the immediate refund of any unused portion of their 2005, 2006 and 2007 R&D tax credits and of the 2008 R&D tax credit that could not be used to offset the 2008 income tax liability.

The Amended Finance Bill for 2009 partly extends this measure. The portion of the 2009 R&D tax credit that will not be used to offset the 2009 income tax liability can be claimed as an immediate refund either when the income tax balance is due (i.e., on 15 April 2009 for calendar year corporations) or as early as January 2010 based on an estimate of the 2009 income tax liability and of the 2009 R&D tax credit. In the latter case, if the amount of the refunded credit exceeds by more than 20% the difference between the actual 2009 R&D tax credit and the actual 2009 income tax liability, the excess will be subject to interest for late payment, increased by a penalty of 5% for corporations and 10% for partnerships. However, as opposed to last year, companies are not entitled to claim an immediate refund in 2010 of any unused portion of their 2006, 2007 and 2008 R&D tax credits.

French real estate transfer tax upon the transfer of shares in foreign companies whose underlying assets mainly consist of French real estate

The French tax authorities have always considered that the French 5% real estate transfer tax is due when shares in a company primarily holding French real estate property are sold, irrespective of whether this company is a French resident or not. However, since this assumption had no legal grounds, the market practice considered that a sale of shares in foreign companies holding French property should not trigger any real estate transfer tax in France as long as no deed or legal document materializing the sale was executed or registered in France. This position was confirmed by French case law. However, the Amended Finance Bill for 2009 provides explicitly that the sale of shares in companies considered as real estate companies for French transfer tax purposes falls within the scope of the French 5% real estate transfer tax, irrespective of the tax residency of such companies. This rule is effective as of 1 January 2010.

Business tax

The Finance Bill for 2010 repeals, as of 1 January 2010, the local business tax (Taxe professionnelle) on tangible assets (i.e., real properties, equipment and movable assets) and replaces it with the Territorial Economic Contribution (TEC), which consists of two different taxes:

• A Real Property Contribution (Cotisation Fonciere des Entreprises), which is only based on real properties (and which, contrary to the former business tax, excludes equipment and movable assets).

• A Contribution on the added value (Cotisation sur la Valeur Ajoutee), which consists of a progressive taxation that can be as high as 1.5% of the added value if the revenue of the French taxpayer is higher than €50m.

The sum of these two contributions is capped at 3% of the added value.

Charles Menard Ernst & Young société d’avocatsTel: +33 1 55 61 15 57Email: [email protected]


ArgentinaThe Argentinean government has signed agreements for the exchange of information with Andorra, Costa Rica and the Bahamas, countries that were included in the list of tax havens, with the intention of reducing levels of tax evasion.

Concern still exists among taxpayers about the diverse allocation criteria used by local jurisdictions that cause differences for turnover tax purposes. This implies that some companies are facing tax claims even when they had paid the total amount of the tax. It is likely that taxpayers will need to defend their position before the Tax Court.

AustraliaATO issues draft Tax Determinations for Private Equity industry

The Australian Taxation Office (ATO) has released two draft Tax Determinations (TD 2009/D17 and TD 2009/D18) aimed at the Private Equity industry. The first determination states the ATO view that private equity structures that involve “treaty shopping” can be caught by the general anti-avoidance rules. This determination gives an example with a similar fact pattern of a recent widely reported court case in which the ATO tried unsuccessfully to enjoin a bank from dispersing profits from an initial public offering (IPO) of a business previously owned by a US private equity firm.

The second determination states the ATO view that income derived by private equity firms from the disposal of assets is held on revenue account as opposed to capital. Therefore, in the future, Private Equity firms will not be able to avail themselves of concessionary capital gains tax (CGT) rates. The position adopted by the ATO seems to be at odds with recent statements by the government indicating a desire to implement tax policies designed to encourage foreign investors to view Australia as a financial hub in the Asia Pacific region (see below).

“Australia a Financial Centre” report is released

From a Tax policy perspective, January saw the release of the Johnson Report entitled “Australia a Financial Centre” and authored by a panel of industry experts including Alf Capito, Ernst & Young Tax Policy head for Oceania and the Far East. The panel, chaired by Mark Johnson, a former merchant banker, made a number of recommendations to the government on how to better position Australia as a financial center. The government has yet to announce whether the recommendations will be accepted, but recent industry feedback and press reports have all been supportive of the report. The report advocates the introduction of an investment manager regime, which may be a useful step forward to resolving the private equity problem that has surfaced from the release of the above tax rulings. The report also advocates other measures, including the abolition of interest withholding taxes on financial institutions.

Australian CFC reform: consultation paper released

In early January, the Australian government released a consultation paper setting out proposed reform of the controlled foreign company (CFC) rules. The reforms were initially announced in May 2009 as part of broader reforms in Australia’s international tax regime. The proposals, which are designed to address Australia’s attractiveness as globalization increases pace, are accompanied by a submissions process whereby documents must be submitted by 1 March 2010.

Country round-up


CanadaGeneral Electric Capital Canada Inc. (GE Canada) wins an important transfer pricing case

The Canada Revenue Agency (CRA) has become increasingly vigilant in auditing and assessing the pricing of cross-border transactions between related parties. Until recently, there was very little Canadian case law on the subject, but increased audit activity is resulting in more transfer pricing disputes working their way through the courts. The first significant decision was GlaxoSmithKline Inc. v. The Queen, 2008 TCC 324, which dealt with the transfer pricing methodology to be used in the context of the purchase of a prescription drug ingredient. The GE Canada decision, released on 4 December 2009, considered the application of the transfer pricing rules to a 1% guarantee fee charged to an indirect Canadian subsidiary by its US parent company. The Tax Court of Canada (TCC) allowed GE Canada’s appeal of adjustments of over $136 million.

The GE Canada decision is important not only because of the magnitude of the proposed adjustments, but also the Court’s interpretation of the arm’s-length principle and its findings with respect to the appropriate transfer pricing methodology. First, with respect to the kinds of comparables to be used in an arm’s-length analysis, the TCC stressed the necessity of maintaining the relevant economic characteristics of the controlled transaction in order to ensure the reliability of the comparisons with uncontrolled transactions. Therefore, the effect of the “implicit support” of the parent company could not be ignored in determining what would have been the Canadian subsidiary’s cost of borrowing in the absence of an express guarantee.

The TCC went on to find that the “yield” approach was the most appropriate transfer pricing methodology in the circumstances. Under the yield approach, the benefit enjoyed by GE Canada as a result of the guarantee was equal to the interest cost savings determined by comparing the interest cost of unguaranteed debt to that for guaranteed debt. In the final analysis, the TCC concluded that the taxpayer’s final credit rating without explicit support would be in the range of BBB-/BB+, which is the borderline of investment-grade paper, as compared to AAA, the highest rating available (and the rating achieved with the guarantee in place). The interest cost savings to the taxpayer based on the differential was determined to be approximately 1.83%. Therefore, the 1% guarantee fee was equal to or below an arm’s-length price under the circumstances.

ColombiaColombian government introduces new tax reform

On 23 December 2009, the Colombian Congress approved Law 1370, which introduced a relatively brief tax reform that was enforced on 1 January 2010. The main effects of the reform are:

1. A new equity tax was created for 2011, 2012, 2013 and 2014. The tax has a rate of 2.4%, for the minimum taxable basis of US$1,500,000 and a rate of 4.8% for net equity that is worth more than US$750,000. The tax is to be declared on 2011 returns but deferred in eight equal payments during the next four years until 2014. Debts between related parties will be treated as equity for determining the taxable basis.

2. The former capital allowance rate of 40% for the acquisition of real productive fixed assets was reduced to 30% effective 1 January 2010 and will no longer apply for companies operating in free trade zones.

A need to continue enforcing the “democratic security” policies of the government, among other concerns, motivated this reform. Corporations that signed legal stability agreements may not be

affected by the reform.

Treaty between Colombia and Chile to avoid double taxation and tax evasion enforced

An agreement between Colombia and Chile to avoid double taxation and tax evasion, regarding income tax and equity tax that was signed on 19 April 2007, came into force on 22 December 2009, when the diplomatic exchange of notes took place. The treaty is based on the OECD model convention and has benefits concerning the tax treatment of corporate profits, dividends, interests, royalties, technical services, technical assistance and consulting, income derived from real estate and capital gains.


GermanyAccording to the Act to Combat Tax Evasion of 29 July 2009 and the respective ordinance of 25 September 2009, special duties to cooperate and special proof requirements are generally to be taken into consideration from 2010 onwards if the respective state is included in a list of uncooperative states that are currently unwilling to exchange information in line with the OECD standards. According to a letter published by the German tax authorities on 5 January 2010, currently no states are qualified as uncooperative in this sense. Therefore, the special duties to cooperate and special proof requirements will not be applied until another letter naming an uncooperative state is published.

The Act to Accelerate Economic Growth was published on 30 December 2009 in the Federal Gazette and therefore came into force on 1 January 2010. The Act includes significant tax benefits to companies, including a group restructuring exception and a built-in-gains exception to the harmful change in shareholder rule, the introduction of an earnings before interest, taxes, depreciation and amortization (EBITDA) carry-forward regarding the general interest expense limitation rule and a group restructuring exception to the Real Estate Transfer Tax. For more information on the Act to Accelerate Economic Growth, please visit the following website: http://www.ey.com/germany.

IrelandThe 2010 Irish Finance Bill was published on 4 February 2010 and is now proceeding to Committee and Report stages, where additional amendments may be tabled. While the impact of transfer pricing provisions in the 2010 Irish Finance Bill will inevitably be the focus of much attention, there are many other measures that are of interest to the business community. Business-friendly enhancements for companies exploiting or developing intangibles and for holding companies are welcome but, as always, the devil is in the detail. The Bill also contains its fair share of anti-avoidance provisions.

Transfer pricing regulations to be introduced

In an effort to bring Ireland into line with its EU counterparts, and reinforce some existing provisions in the Irish Tax Code, transfer pricing regulations are to be introduced. The key features of this new regime are as follows:

• The regulations will be effective for accounting periods beginning on or after 1 January 2011.

• The regulations will apply to any “arrangement” between associated enterprises involving goods, services, money or intangible assets, but only where those transactions meet the definition of being an Irish trading transaction for one or both of the parties.

• The regulations will apply where Irish trading receipts are understated or trading expenses are overstated.

• “Grandfathering provisions” will apply generally to all existing transactions where the terms are agreed to prior to 1 July 2010.

• New arrangements entered into after this time or changes in the agreed terms of existing arrangements will be within the scope of the new rules.

• To establish an arm’s-length price, the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations will be adopted.

• Records need to be kept sufficient to support the arm’s-length nature of the price.

• Transfer pricing documentation, where required, should be prepared on a timely basis.

• The rules will apply to both domestic and cross-border transactions involving a company carrying on an Irish trade.

• There are exemptions from the rules for small and medium-sized enterprises, specifically companies with fewer than 250 employees and either turnover of less than €50m or assets of less than €43m.

• Auditing of transfer pricing cases will be restricted to specifically designated people in the Irish Revenue Commission.

• There is a mechanism to eliminate double taxation in domestic transactions.

Enhancements for holding companies

In a move that will improve Ireland’s attraction as a destination for holding companies, the Bill provides for a number of enhancements to the existing tax treatment of dividends received by Irish resident companies. The enhancements include (i) charging tax at 12.5% (instead of 25%) on certain foreign dividends paid out of trading profits from countries with which Ireland does not have a tax treaty and (ii) simplifying the arrangements under which foreign dividends are treated as sourced from trading or non-trading profits. A new exemption for foreign dividends from portfolio investments (holdings of less than 5%) where the income represents trading income, while a step in the right direction, is not unexpected given EU law in this area.


Ireland (cont’d.)Intellectual property

The Bill introduces a new entitlement for trading companies to unilateral credit relief with respect to withholding taxes on royalty income from non-treaty countries. In addition, certain amendments have been introduced in relation to the application of withholding tax on outbound patent royalty payments. Where certain conditions are met, such payment can be made free of withholding tax.

Domicile levy — minimum tax for Irish citizens resident abroad

Effective 1 January 2010, all Irish citizens who are domiciled in Ireland will be liable to a “domicile levy” of €200,000 where the following conditions are met:

• Their worldwide income exceeds €1 million

• They have assets located in Ireland with a value in excess of €5 million on 31 December of the relevant year

The domicile levy is subject to self assessment and is payable to the Irish Revenue Commissioners on or before 31 October in the year following the year of valuation. The levy payable will be reduced by the amount of income tax paid with respect to the tax year ending on the valuation date.

Key investment fund and asset management tax incentives

The Bill contains very positive news for the Irish asset management and investment funds industries. Proposed changes will enhance Ireland’s attractiveness as a location for regulated funds and demonstrates that it is an ideal location for UCITS IV (Undertakings for Collective Investments in Transferable Securities) management companies and UCITS funds.

VAT on public bodies and local authorities

The 2010 Irish Finance Bill provides that effective 1 July 2010, certain charges by public bodies including local authorities will be subject to VAT notwithstanding their status as public bodies. The charges in question relate to activities that may lead to a distortion of competition with private operators and include charges such as waste collection, landfill and recycling services; off-street parking; toll roads and the operation of leisure facilities. This provision may result in higher costs to customers using public services.

JapanOn 22 December 2009 the Japanese government released an outline of its 2010 Tax Reform Proposal (TRP). The proposal will form the basis of a proposed bill and is expected to be introduced in the Diet in February 2010. If approved, the bill is expected to become law effective either 1 April or 1 October 2010, depending on tax reform provisions. The key provisions of the 2010 Tax Reform Proposal include the following:

• Intra-group transaction tax-related changes:

• Tax deferral for certain intra-group asset transfers

• Other intra-group tax-related changes

• Loss denial on intra-group share redemptions

• Relaxation of certain group tax consolidation rules

• Modifications to the Japanese anti-tax haven rules

• Other tax reforms (especially with respect to taxation of “overseas issued” corporate bonds and on Tokutei Mokuteki Kaisha (TMK) structures. A TMK is a special-purpose company that is generally used to hold real property of certain types of bonds).

You can read more about the proposed reforms at www.ey.com/2010JapanTaxReform.


MexicoPossible changes for maquiladoras

The Mexican government has released draft rules to changes to the maquiladora (IMMEX)programthat provide incentives to the manufacturing for export industry. While any company with an IMMEX Program has customs incentives, only those that qualify as maquiladoras enjoy income and single-rate business tax incentives. Under the proposed rules, the definition of maquila activities would now require that the preponderant raw materials (in value) are imported on a temporal basis. Maquiladoras would still be permitted to use local materials in their manufacturing process. In addition, in order to qualify for the tax incentives, the machinery, equipment and tools used in the manufacturing process would have to be imported on a temporary basis or would have to be equipment that was changed from temporary to permanent importation and that did not previously belong to a Mexican taxpayer. Some of these proposed changes are aimed at curbing the conversion of Mexican companies from fully fledged manufacturers into maquiladoras, a recent trend that has allowed companies to reduce their tax bill. The definition of maquiladora operations would also be expanded to cover activities such as testing, labeling, packaging and application of conservatives, among others.

Constitutional litigation

The Supreme Court of Justice will conduct a public hearing on the constitutionality of the Single Rate Business Tax. This tax, enacted in 2007, has been challenged by approximately 32,000 companies. Overall, there are 16 different counts based on the constitutional principles of legality, equality and proportionality. Six attorneys for the plaintiffs were selected to speak in the public hearing by lottery, while attorneys for the President and both chambers of Congress will defend the constitutionality of the tax. The public hearing is part of an ongoing effort by the Supreme Court of Justice to provide transparency to their work.

MalaysiaMalaysia’s commitment to OECD standards on exchange of information [EOI]

Malaysia committed to the OECD standards on EOI in mid-2009 and has since been making earnest efforts to comply with the standards. The Malaysian government has to date signed EOI protocols with nine treaty partners to date and is on track to completing this exercise with more treaty partners by the end of February 2010 to move on to the “white list.” Various legislative changes to give effect to this commitment have since been gazetted or are in the final stages of being gazetted.

Transfer pricing: arm’s-length price for related-party transactions now a requirement

Effective 1 January 2009, specific legislation under the new Section 140A of the Income Tax Act, 1967 (ITA) has been introduced. The law now requires taxpayers to use arm’s-length pricing for related-party transactions and empowers the Director-General of Inland Revenue (DGIR) to make adjustments for related-party transactions which are not conducted on an arm’s-length basis. Furthermore, as a measure to enable taxpayers to obtain greater certainty that their related-party transactions, are at arm’s-length, a new Section 138C in the ITA on APAs has also been introduced. The tax authorities are expected to release rules/guidelines pertaining to the new legislation.

In addition, with the recent implementation of a dedicated division, the Multinational Tax Department (MTD), within the Inland Revenue Board (IRB) of Malaysia, it is expected that the IRB will continue with its focus on transfer pricing and on enforcement efforts for an increased level of compliance from taxpayers.

Deferral of thin capitalization rules

The legislation on thin capitalization, which was supposed to be effective as of 1 January 2009 has been deferred to a date to be determined by the Ministry of Finance.

Goods and Services Tax (GST)

The Goods and Services Tax (GST) Bill was tabled for the first reading in Parliament on 16 December 2009 and is expected to be passed in March 2010. The GST, when introduced, will replace the existing sales and service tax. The Malaysian government has proposed that the GST will be levied at a rate of 4% and has indicated that it will be introduced in the second half of 2011. The introduction of the GST is expected to have a significant impact on all businesses. In the meantime, consultative talks between the Tax Review Panel of the Ministry of Finance with various industry groups, associations and professional bodies are actively being carried out with the aim of explaining the bill and obtaining feedback from these groups.


Middle EastEgyptThe Egyptian Tax Authority recently issued a new Ministerial Decree no. 771 of 2010. The new Ministerial Decree outline the guidelines towards the applicability of double tax treaty reduced rates for amounts paid to non-resident offshore entities according to article 56 of the income tax law.

Main aspects of the decree

According to article (56) of the income tax law no 91 f 2005 the Egyptian entity paying amounts to non-residents is obliged to deduct 20% withholding tax.

To benefit from the tax rates provided by DTA (Double Tax Avoidance treaties) regarding royalties or interests, the recipient entity or its legal representative shall submit an application to the Tax Authority within six months commencing from the date of receiving the revenue to apply the rate stated in the treaty and to request for refund of tax differences on the form designed for this purpose (Form No. 1-Withholding tax refund of withholding tax). The form must be accompanied by arrange of documents in order to be accepted by the authorities.

The provisions of this Decree shall be applied starting from January 2010, and the Tax Authority should reply to the application within ninety days (90) from the date of receiving the application. In cases where no reply is received from the Tax Authority during the mentioned period, the recipient of revenue has the right to submit an application to the competent authority in his state of residency to apply Mutual Agreement Procedures provided in the treaty.

Transfer pricing documentation likely to be requested in the future

The tax Authorities have yet to finalize a complete transfer pricing assessment and it is anticipated that for 2009 tax filings the tax authority will begin to request tax payers to submit transfer pricing studies in support to the annual tax return.

Expected amendments to tax law and executive regulation

There are proposed amendments on the Income Tax Law under discussion. One amendment concerns the level of documentation required for transfer pricing and guidelines submitted by the taxpayers to the tax authority along with the annual tax declaration.

There are also ongoing internal discussions within the Tax Authority about the definition of the related parties, as per the current income tax law in comparison with the OECD definition. This may lead to make an amendment to the said definition in the income tax law in order to make it compliant with the OECD model.

IraqA new Income Law will be issued this year by the Iraqi Tax Authorities. It is expected that the corporate tax rate on foreign oil and gas per the new Income Law will be 35%.

LibyaLibya is set to issue a new Tax Law by March 2010. Expectations are that the law will include the following provisions:

• Corporate rates will be reduced from progressive rates rising to 40% on profits above LYD 2 million (USD$1.6 million) to a flat rate.

• In the future, tax will be applied only on an actual basis rather than a deemed basis.

• Government employees will be exempt from payroll taxes.

• Tax on supply will be reduced.

• Tax on subcontractors will be reduced.

• The statute of limitations will be amended.

• Investment Law 5/1997 and Tourism Law 7/2003 will be “merged.”

JordanOn 30 December 2009, a new Tax Law was issued by Jordan’s tax authorities, which is effective as of 1 January 2010. In summary, corporate income tax rates were reduced from 35% to 30% for banks, while the income tax rate has been revised to 24% for insurance, foreign exchange dealers, telecommunications companies, finance and leasing companies. The non-resident withholding tax was reduced to 7%, while personal income tax rates were reduced, with the first tranche of taxable income of JD12,000 at 7% and the remainder at 14%.


The NetherlandsIn a letter dated 5 December 2009, the Dutch Ministry of Finance announced the withdrawal of proposals reforming the taxation of interest income and expenses, as these could be harmful to the business and investment climate in The Netherlands. This decision is partly based on feedback received by the Ministry from taxpayers, tax professionals and tax scholars on proposals issued earlier in 2009. Together with the relaxation of the participation exemption, which came into effect on 1 January 2010, the letter of 5 December emphasizes that maintaining a stable and competitive corporate income tax legislation remains one of the priorities of the Dutch government.

Move to full territorial tax system for foreign branch income

Under current Dutch law, a taxpayer is taxed on their worldwide income. This means that if a Dutch taxpayer generates 100% of Dutch income and has a foreign permanent establishment suffering a loss of 40%, corporate income tax effectively is due on 60%. If the foreign permanent establishment generates a profit in a future year, that profit will not be exempt, but will be taxable in The Netherlands to the amount of the foreign loss that reduced the taxable basis in earlier years. This system provides for a temporary benefit or even a permanent benefit (in case the permanent establishment is never profitable).

The government is now considering introducing a full territorial tax system, implying that foreign results will no longer be part of the taxable profit. Consequently, foreign losses would no longer be deductible from taxable profit. Losses would only be deductible, under certain conditions, in the case of final discontinuation of the foreign branch (comparable to liquidation losses under the participation exemption). It also implies that going forward, foreign branch profits would be exempt from Dutch taxation even if those profits were not subject to local taxation. Under today’s rules, that is typically already the case for branches located in jurisdictions with which The Netherlands has entered into a tax treaty. After introduction of this change, this would also apply absent a tax treaty or possibly in cases where the tax treaty contains a subject-to-tax requirement for branch profits. This new legislation is expected to be introduced as of 1 January 2011.

No mandatory group interest box (“groepsrentebox”)According to this letter, the special regime for the taxation of interest as proposed in a previously issued consultation document will be abandoned. This means that there will be no mandatory group interest box (“groepsrentebox”) resulting in an effective tax rate of 5% on related-party interest income and expenses. This raises a question as to whether The Netherlands will still be a preferred location for group finance companies.

Fiscal unity with a foreign subsidiaryThe Dutch Corporate Income Tax Act does not allow for fiscal unity with a foreign subsidiary, meaning that the tax losses of a foreign subsidiary cannot be set off against profits of the Dutch parent company. Procedures are pending with the European Court of Justice, which has to decide if the Dutch restriction is compliant with European law. In the State Secretary of Finance’s letter, it was also proposed to abolish the possibility for Dutch companies to set off losses of a foreign permanent establishment against domestic profits. This will rule out setting off any foreign losses against domestic profits.

Disclosure arrangementLike many other countries, the Dutch government is fighting “black” savings housed in foreign savings accounts. A special disclosure arrangement (“inkeerregeling”) offers the possibility to declare foreign savings previously hidden from the Dutch tax authorities. These savings will be taxed, but without additional penalties. If the tax authorities learn of hidden foreign savings that have not been declared, the penalties could total up to 300% of the tax due.

Wage tax exemptions for standard professional expense allowancesFrom 2011 onwards, the wage tax exemptions for standard professional expense allowances will significantly change. Currently, these exemptions are assessed per employee. From 2011 onwards, employers can grant tax-free allowances of up to 1.4% of the total amount of wages paid to all employees. Any additional allowances will be taxed at 80%. This is a significant change from the current system and employers will need to carefully consider their future policy for employee benefits.


New ZealandApplication of New Zealand’s General Anti-Avoidance Provision

In late December, four of New Zealand’s largest trading banks settled litigation cases with the New Zealand Inland Revenue Department (NZIRD) to the amount of NZ$2.2 billion in total. The cases related to the application of New Zealand’s income tax general anti-avoidance provision (GAAP) to certain structured finance arrangements involving equity investments by a special purpose subsidiary of the relevant banks in overseas counterparties.

The settlements mean that the High Court judgments for Westpac and the Bank of New Zealand will stand and we are informed that the NZIRD (in conjunction with Crown Law) is considering the long-term implications of these judgments on the law of Tax Avoidance in New Zealand. A new document setting out the Commissioner of Inland Revenue’s official view of the application of the GAAP following the recent judicial developments in this area is expected, but no likely release date has yet been indicated. It is reliant upon practitioners and commentators to apply these cases without the benefit of official guidance from the Inland Revenue.

Meanwhile, the NZIRD has widened its hybrid financing investigations to include Mandatory Convertible Notes (MCNs). Currently, there are litigation cases before the High Court involving Optional Convertible Note (OCN) financing arrangements, to which the Commissioner has applied the GAAP. The first OCN case is expected to be heard later this year. MCNs are hybrid debt instruments that automatically convert to equity on maturity. OCNs are similar debt instruments, but the lender may choose to convert to equity in the borrower. The Commissioner of Inland Revenue has targeted hybrid and structured financing in his published “Compliance Focus 2009/2010.” Currently, there are MCN structures going through New Zealand’s statutory disputes procedure, and we understand that there may be court proceedings filed in one or more cases in the near future.

Tax Working Group Review

The Tax Working Group — a panel of New Zealand tax professionals including private sector and university specialists — has been asked by the government to examine several tax reform alternatives in an effort to fill some perceived gaps in the country’s tax system. Among the recommendations in their final report, made public on 20 January 2010, the Group advocates:

• Alignment of the top personal, corporate and trust tax rates.

• The imputation system should remain, subject to changes in Australia.

• A reduction in personal tax rates across the board, especially the top personal tax rates of 38% and 33%. This could accompany an increase in the GST rate if implemented.

• A low-rate land tax to offset tax reductions in other areas.

The Group had reservations about a comprehensive or even partial CGT and did not favor a more targeted approach, which would include taxing returns from capital invested in residential rental properties on the basis of a deemed notional return calculated using a risk-free rate. Finally, they recommended a comprehensive review of the welfare policy and how it interacts with the tax system, with the objective of reducing high effective marginal tax rates.

PeruOn 21 January 2010 the Peruvian Executive Branch enacted the Regulations of the Capital Gains Tax effective as of 1 January 2010.

CGT rate

CGT will be 5% if the transaction takes place within Peru. The regulation defines transactions as taking place within the country if, firstly, securities are registered in the Peruvian Stock Exchange, and secondly, securities are traded within the Peruvian Stock Exchange. If these requirements are not met, the CGT rate is 30%.

Determination of the tax basis of securities acquired before 1 January 2010 (tax basis step-up)The law established that the basis to determine the CGT rate from 2010 will be the value of such securities as of closing on 31 December 2009, provided that the value is not lower than the price paid upon acquisition. The procedure to determine the tax basis is as follows:

• Listed shares — The last value that shares had in the Peruvian Stock Exchange in 2009. If listed shares were not traded in 2009, the basis will be the book value, according to the audited balance sheet that closed on 31 December 2009.

• American depositary receipt (ADR) — The last value that ADRs had in the Peruvian Stock Exchange in 2009. If ADRs were not traded in 2009, the basis will be the last value that they had in a foreign exchange in 2009.


RussiaAmendments to the Procedural Tax Legislation of the Russian Federation effective as of 1 January 2010

Provisions have been introduced that require the tax authorities to pay penalties if they are late in annulling decisions on the suspension of taxpayers’ operations on bank accounts. This requirement should encourage tax authorities to abide by the time limits set by tax legislation and adopt decisions in a timely manner. The introduction of this requirement provides additional support for taxpayers’ rights, as tax authorities previously tended to adopt decisions on the suspension of operations on taxpayers’ bank accounts outside the established time limits, which had adverse consequences for taxpayers’ business activities.

Until now tax authorities have frequently requested the same documents from a taxpayer on multiple occasions during the course of conducting tax control measures, resulting in the significant diversion of taxpayers’ material and human resources. As of 1 January 2010 this problem has been resolved, as Russian tax legislation now prohibits documents from being requested from a taxpayer a second time if the taxpayer has already presented the documents in question to the tax authorities. The introduction of this provision will certainly reduce the amount of paperwork that has to be presented by a taxpayer to the tax authorities and will significantly reduce the cost to organizations of diverting material and human resources.

One of the contentious issues in the tax legislation of the Russian Federation, that of the right to correct errors made in calculating the tax base, has been resolved effective 1 January 2010. Previously, a problem of this kind would ultimately have to be dealt with through the courts, thus placing an additional material and moral burden on taxpayers. Now, errors relating to prior tax periods that have resulted in the overpayment of tax may be corrected by the taxpayer in the current tax period.

Introduction of the claim-based procedure for VAT reimbursement for certain categories of taxpayers

The process of reclaiming VAT paid to the budget of the Russian Federation is one of the most pressing problems as far as the Russian taxation system is concerned. It is one that is widely encountered, especially by exporters and companies that are at the early stages of long-term projects, when significant investment is needed. The main problem is the amount of time taken up by in-house tax audits: it can take tax authorities over four months to establish whether or not a reimbursement claim is valid and adopt a corresponding decision.

With a view to resolving this issue, effective in 2010, a claim-based procedure for VAT reimbursement has been introduced in Russia in place of the former authorization-based procedure. Certain categories of taxpayers are granted the right to claim a VAT refund (credit) on the basis of a tax declaration alone and before the completion of an in-house tax audit. This right will enable certain categories of taxpayers to obtain VAT reimbursement more quickly without having to wait for the completion of a tax audit. At the same time, the effectiveness of tax control is not diminished.

Peru (cont’d.)The Regulations expressly state that this procedure is applicable to non-resident corporate shareholders even if the subsequent transfer is not affected through the Peruvian Stock Exchange. Hence, even if Peruvian ADRs are traded in a foreign exchange in 2010, the stepping up procedure will be applicable.

Non-taxable exchange-traded funds (ETFs)

For purposes of the exemption, ETFs are defined as investment vehicles in which the quotas (ETF units) are listed in a stock exchange, the value of which derives from a portfolio of securities and that replicate a specific index or portfolio of assets. Regulations have established that the tax basis of the securities received upon the redemption of ETF units would be either the tax basis of such securities when they were transferred to create ETF units or the tax basis of the acquired ETF unit.

Direct payment of capital gains derived from the disposal of securities by non-residents

In the case of transactions within the Peruvian Stock Exchange, the CGT must be paid directly by the non-resident seller. Non-residents shall pay the CGT within the first 12 days of the following month in which the payment is received. The de minimis exemption of five Taxable Units yearly (approximately US$6,000) established in favor of individuals (resident and non-resident) will be applied in each month until the minimum amount is exceeded.

The regulations have stated that in these cases the tax basis certification would not be required. This rule is also applicable to the transactions that were carried out during January 2010.


Russia (cont’d.)Reform of the unified social tax

As of 1 January 2010, the payment of the unified social tax (UST) has been replaced by a system of contributions to state non-budgetary funds. This change is aimed first and foremost at reforming the taxation system of the Russian Federation and boosting the tax component of the budget of the Russian Federation. The negative implication for taxpayers is, without a doubt, the increase in the tax burden.

Turkey2010 brings significant developments to taxation in Turkey. Some were expected while others included bold movements from the government that came as a surprise to practitioners as well as taxpayers.

Increases in some tax rates

The 2009 budget was closed with a deficit figure in line with expectations at US$34.8 billion. The government was expected to take action to increase central revenues for 2010 in order to close this deficit, which is expected to continue into 2010 and 2011. The first action saw the government enact several regulations increasing the special consumption tax rates on petroleum products, fuel oil, alcoholic beverages and tobacco products. These items are thought to be the main income-increasing sources of the government for 2010. Currently, the total special consumption taxes comprise approximately 25% of the total tax revenues of Turkey.

A somewhat unexpected move was the increase in the rate of stamp tax, a kind of tax applied on a range of commercial papers. The general rate of 0.75%, which has remained steady for many years, was increased to 0.825%. Even though the total weight of this tax in the total tax revenues is not very significant (around 2.5% of the total), it is seen as a discouraging factor in contracts regulating high-value transactions. In addition to this, the fees applied by the government on a wide range of administrative operations were also increased (both the constant and the proportional fees were increased by 10%). An important example of these fees is the title deed fee, which is applied in the transfer of real estate property. The fee, which was applied at 1.5% for the seller and buyer separately, has increased to 1.65% of the value of the real estate transferred.

Other administrative amendments by the Revenue Administration

Obtaining a ruling for a specific transaction was not a systematic application in Turkey until the Ministry of Finance announced with a recent Communiqué that a new ruling system will be applied effective as of the date of the Communiqué. According to the new system, the rulings to be given to taxpayers by the different tax offices throughout the country will be reviewed by a central committee in the General Directorate of Revenues in Ankara, preventing different approaches and positions appearing on similar issues. In addition, the rulings will be announced electronically via the internet. Practically, with the provisions of this new Communiqué, the binding characteristic of the rulings were weakened and the chance of protection against the potential tax penalties for the taxpayers was made more difficult.

Enactment of Law No. 5951

A new law was ratified by the General Assembly of the Turkish Parliament on 28 January 2010 and has subsequently been enacted in the Turkish Parliament. It includes various rules on the business and labor regulations of Turkey, such as an extension of the incentive system applied in the less-developed provinces of Turkey until the end of 2012. On the other hand, the new law foresees new annual fees to be levied on banks per each branch. In the 2008 and 2009 financial periods, when the financial sector companies in many countries suffered hardship, the financial sector of Turkey did comparatively well with healthy profit levels. Now, the government seeks to create a new income source for itself from banks amounting to 400 million Turkish Lira yearly(approximately US$270 million) from these profits.


United KingdomThe UK held its Pre-Budget Report (a mini-Budget) in December where it announced an additional 50% tax on bonuses of banking employers, a 1/2 percentage point increase in social security rates, a 10% tax rate for income from patents, and a number of other elements. These were designed to raise additional revenues while supporting the competitive position of the UK tax regime.

The draft legislation for the 50% Bank Payroll Tax (a windfall tax payable on bonuses in excess of £25,000), included in December’s Pre-Budget Report, inadvertently extended the scope of the tax beyond “banks” and the government has been revising this to refocus (broadly) on employees engaged in proprietary trading rather than customer-facing activities. However, there remains considerable uncertainty over the precise coverage and further development is expected. The government now expects to receive more tax revenues than the net £550m originally envisaged. However, the government expects the tax to lapse once the new regulatory regime is in place.

The Treasury has confirmed that the new “Patent Box” to be introduced in the UK in 2013 will be restricted to patents and not extended to other forms of intellectual property. This is on the basis of cost constraints but also because such patents represent a source of competitive advantage for the UK and such arguments are not as readily applicable to other forms of IP. This will be a disappointment to many groups.

Building from the UK’s new dividend exemption, the Treasury has been working on the new CFC regime and has published a “direction of policy” document. This document will set the tone for how the UK’s tax regime is likely to develop. The document proposes many changes, many of which are intended to avoid being headquartered in the UK from imposing obligations and charges on activities that are unconnected with the UK. On the face of it, many of these changes appear helpful. The challenge will be for these changes to be translated into workable legislation, as well as avoiding the good policy intentions being undermined by overly burdensome or clumsy implementation. The document also identifies a number of areas where HMRC will be seeking to tighten the existing rules, including a new super-royalty where IP is sold by the UK to other group companies and greater focus on whether IP is actively managed. It also questions whether IP management outsourced within a group would actually have been outsourced to third parties in practice. The consultation runs through to April 2010.

From a tax administration standpoint, one of the most interesting new developments is HMRC’s focus on exploring ADR. Until very recently, HMRC had adopted a Litigation Settlement Strategy in relation to disputed issues, whereby if HMRC get a greater than 50% chance of success from an opinion from their Solicitors Office/Queens Counsel, they would litigate the issue. This has led to a significant backlog in cases awaiting litigation and has closed off HMRC’s traditional pragmatic basis of resolving disputes. Ernst & Young is in dialogue with HMRC regarding the parameters the proposed ADR program will take. It is anticipated that it will follow the same arbitration and reconciliation approach that has been used in other legal disputes.

HMRC is continuing to exchange significant amounts of information with other fiscal authorities and there is a growing focus on permanent establishment risk. Where a disclosure is made to the tax authorities of previously undisclosed income/gains in one country, the authorities are seeking confirmation in relation to any employee who may have known about the failure, even where the individual is based in any jurisdiction. As an example, a disclosure in Germany may mean that UK-based employees need to explain their knowledge of the background to the disclosure, which demonstrates the need for a truly integrated global tax risk strategy.

Finally, HMRC has announced another “amnesty,” this time focused on medical professionals. They are seeking information from a number of national health authorities and sources of third-party payments, such as medical insurers, to root out non-compliant doctors and dentists who have failed to disclose their private work. It seems that the UK has gone from a position where they did not want to have any amnesty to having three in quick succession. Furthermore, it is likely there will be others as they target different sections of the public in specific campaigns.


United StatesHealthcare legislation continued to dominate the US legislative debate through the last quarter of 2009, but its prospects are now uncertain. After a special election provided senate republicans with enough votes to filibuster legislative debate, major initiatives such as healthcare, climate change and tax reform will now require some bipartisan support.

Immediate legislative action is required to raise the debt ceiling of the federal government and to extend expired provisions (including the R&D tax credit and now-expired estate tax). The congressional debt limit debate and potentially a presidential executive order are expected to include a deficit reduction commission that would propose possible tax increases and entitlement program spending reductions. Such a commission would not complete its work until after the November 2010 congressional elections.

The president’s FY2011 budget proposals were released 1 February 2010, and included many of his prior budget tax proposals, plus some revised and additional proposals. The President’s budget again proposes to make the research credit permanent, repeal last-in first-out inventory accounting, codify the economic substance doctrine, tax carried interest as ordinary income, and repeal a host of tax preferences for oil, gas and coal companies. Also again, the budget would allow the 2001 Bush tax cuts to expire for taxpayers with annual incomes exceeding $250,000 (married) or $200,000 (single) with the top rate increasing to 39.6% in 2011, and would limit the value of itemized deductions to 28% for high-income taxpayers.

The budget does not include a proposal from last year to curtail use of the “check the box” rules, and limits the deferral of foreign source deductions to interest expense only. New in this year’s budget are proposals to impose a “financial crisis responsibility fee” on large financial institutions, to tax currently excess returns associated with transfers of intangibles to low-taxed affiliates, modify the worker classification rules, and create $5 billion worth of additional clean energy incentives.

The release of the administration’s FY2011 budget proposal is just the start of the process and represents an identification of the administration’s tax priorities. The congressional tax-writing committees, the House Ways and Means Committee and the Senate Finance Committee will each play a key role in the development of any legislation involving potential tax changes. Senior members of both committees have expressed the view that the policy and economic significance of the administration’s tax proposals underscore the need for careful consideration in the context of more fundamental tax reform. Nevertheless, the potential need for revenue to pay for other legislative initiatives suggests that some of the tax proposals may be on the table as potential revenue offsets.

The President’s Economic Recovery Advisory Board tax reform task force delayed the release of its options paper last autumn. There is expected to be discussion of business tax reform, particularly in the international area, in the congressional tax-writing committees, but enactment of major reform is not expected in 2010, an election year. The corporate community is bracing for further targeting for tax increases to help offset the cost of other legislation.

VenezuelaFollowing the intention of the Venezuelan Tax Administration to modernize its income tax collecting system from 2010, electronic filing through the Venezuelan Tax Administration website will be mandatory for all withholding tax agents.

A modification to the law settling out the model bylaws for joint venture companies engaged in hydrocarbon activity recently came into effect. The change is related to the manner in which a 3.33% additional royalty payable by such enterprises must be paid to the Republic of Venezuela. Accordingly, 1.11% of this additional royalty is to be distributed as follows:

• 30% to the municipalities where the primary activities of the mixed company are executed.

• 70% to the rest of the municipalities where the oil activities are conducted, proportional to the population and human development of such jurisdictions.

• 2.22% must be designated to the Special Fund for Popular Power (FOPO) administrated by the National Executive, dedicated to financing endogenous development projects.

Although the 3.33% royalty amount was not modified, the new regulation gives powers to the National Executive to dispose of the funds. Currently, there are no controls on how the funds assigned to the FOPO should be distributed other than that they should be used to finance endogenous development projects. It is not clear what is required to characterize a project as being endogenous in nature.


Country Tax policy Email/telephone

Tax controversy Email/telephone

Argentina Jorge Gebhardt [email protected] +54 11 45102203

Jorge Gebhardt [email protected] +54 11 45102203

Australia Alf Capito [email protected] +61 2 8295 6473

Howard Adams [email protected] +61 2 9248 5601

Belgium Koen Marsoul [email protected] +32 (0)2 774 9954

Johan Van Caillie [email protected] +32 (0)2 774 9351

Brazil Romero Tavares [email protected] +55 11 2573 3444

Romero Tavares [email protected] +55 11 2573 3444

Canada Jim Morrisey [email protected] +1 416 943 3325

Daniel Sandler [email protected] +1 416 943 4434

Chile Maria Javier Contreras [email protected] +56026761000

Macarena Navarette [email protected] +5626761679

China Becky Lai [email protected] +86 10 58152830

Owen Chan [email protected] +852 2629 3388

Colombia Margarita Salas [email protected] +57 1484 7110


Dominican Republic

Juan Carlos Chavarría Pozuelo [email protected] +809 472 3973

Ramiro Bravo [email protected] +52 (81) 8152 1829

European Union

Klaus von Brocke [email protected] +49 89 14331 12287

Arjo van Eijsden [email protected] +31 88 40 78411

Finland Gunnar Thuresson [email protected] +46 8 520 592 20

Gunnar Thuresson [email protected] +46 8 520 592 20

France Charles Menard [email protected] +33 (0)1 55 61 1557

Frederic Laureau [email protected] +33 1 55 61 1877

Germany Ute Witt [email protected] +49 3025 471 21660

Jürgen Schimmele [email protected] +49 211 9352 21937

Hanno Kiesel [email protected] +49 711 9881 15266

Hong Kong Becky Lai [email protected] +86 10 58152830

Owen Chan [email protected] +852 2629 3388

Contacts




India Satya Poddar [email protected] +91 11 4154 0000

Rajan Vora [email protected] +91 22 6665 5000

Ireland David Smyth [email protected] +353 1 2212 439

P.J. Henehan [email protected] +353 1 2212 420

Italy Maria Antonietta Biscozzi [email protected] +39 02 8514 312

Maria Antonietta Biscozzi [email protected] +39 02 8514 312

Japan Hiroshi Namba [email protected] +81 3 3506 2603

Masaaki Ishida [email protected] +81 3 3506 2679

South Korea Jong Yeol Park [email protected] +822 3770 0904

Dong Chul Kim [email protected] +822 3770 0903

Luxembourg Charles Menard [email protected] +33 (0)1 55 61 15 57

Frederic Laureau [email protected] +33 (0)1 46 93 60 00

Malaysia Azhar Lee [email protected] +603 7495 8452

Azhar Lee [email protected] +603 7495 8452

Mexico Carlos Cardenas [email protected] +52 (55) 5283 1320

Ramiro Bravo [email protected] +52 (81) 8152 1829

Middle East Mohammed Desin [email protected] +96626108500

Mohammed Desin [email protected] +96626108500

The Netherlands

Marnix van Rij [email protected] +31 88 40 73857

Arjo van Eijsden [email protected] +31 88 40 78411

Peru Roberto Cores [email protected] +511 411 4411


Poland Agnieszka Talasiewicz [email protected] +48 22 557 72 80

Marcin Baran [email protected] +48 22 557 7353

Russia Alexandra Lobova [email protected] +7 495 705 9730

Alexandra Lobova [email protected] +7 495 705 9730

Singapore Gek Khim Lim [email protected] +65 6309 8452

Jesper Solgaard [email protected] +65 6309 8038

South Africa Corlie Hazell [email protected] +27 11 772 3990

Corlie Hazell [email protected] +27 11 772 3990




Spain Ramon Palacin Sotillos [email protected] +34 91 572 74 85

Javier Albors Fernandez [email protected] +34 93 366 38 32

Sweden Gunnar Thuresson [email protected] +46 8 520 592 20

Gunnar Thuresson [email protected] +46 8 520 592 20

Switzerland Bernhard Zwahlen [email protected] +41 58 286 6362

Peter Brülisauer [email protected] +41 58 286 4443

Taiwan Albert Chou [email protected] +886 2 2720 4000

Chichang Hsu [email protected] +886 2 2720 4000

Turkey Erdal Calikoglu [email protected] +90 212 368 53 75

Erdal Calikoglu [email protected] +90 212 368 53 75

United Kingdom

Chris Sanger [email protected] +44 (0)20 7951 0150

Mark Bilsborough [email protected] +44 (0)20 7951 8247

Bob Brown [email protected] +44 (0)20 7951 4724

Chris Oates [email protected] +44 (0)20 7951 3318

United States

Tom Neubig [email protected] +1 202 327 8817

Barbara Angus [email protected] +1 202 327 5824

Debbie Nolan [email protected] +1 202 327 5932

Rob Hanson [email protected] +1 202 327 5696

Elvin Hedgpeth [email protected] +1 202 327 8319

Bob Ackerman [email protected] +1 202 327 5944

Venezuela Alaska Moscato [email protected] +582129056672

Katherine Pinzón [email protected] +582129056685


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EYG No. DL0129

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Ernst & Young’s Tax Policy and Controversy services The economic downturn and its impact on profits is increasing the pressure on tax directors. Rapid globalization has brought increasing interconnectivity between businesses, and permanent shifts in the flow of capital. Tax departments are bearing the responsibility of more corporate risk than ever. Tax now has a higher profile, not only with company management but also with shareholders, regulators, the media and other industry observers.

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