19 Aug 2013
Tax and transparency have never been higher up the agenda than in recent months. On top of the political interest in tax and transparency, civil society organisations (CSOs) and the media have kept up the momentum of their investigations into the tax affairs of multi-national companies.
It’s clear that the international tax systems need urgent review to be fit for purpose in today’s increasingly global and digital economy (see page 27). But in the meantime, the unprecedented scrutiny of tax, makes it vital that companies’ tax reporting can be easily understood and helps to build trust.
Good tax reporting should consider the whole story around tax. Commentators are developing an expectation of how much tax businesses should pay and then comparing that with company information. Gaps bet ween that expectation and the reality can damage trust – and it ’s up to companies to make sure that the expectations are appropriate in the first place.
A well-communicated tax strategy says more than just releasing stacks of information. The more data there is, the more open it is to misinterpretation, and the greater the risk that the real message is lost in a noise of numbers.
Anywhere that a company’s everyday operations may not appear in line with its communicated approach to tax is a risk area, and is likely to lead to questions about its trustworthiness. Companies need to explain the position or risk misunderstanding.
Increasingly, organisations are discussing their strategies around tax, but companies also need to show how the strategy is applied in practice. Explaining your ‘total tax contribution’ can help explain to stakeholders the impact on the business of all the taxes paid not just corporation tax (which forms, on average, only 8% of the government’s total receipts).
Total Tax Contribution (TTC) splits taxes into taxes borne and taxes collected – or those that are a cost to the business and those that are not. It can help give a clearer picture of taxes paid even when corporate income tax payments are low perhaps due to poor results, the use of prior year losses, capital investment or the application of tax incentives for investment or research.
Country-by-country tax reporting is also becoming popular with stakeholders, and the question “how much tax do you pay in each country?” is unlikely to go away.
The idea is not new. The extractive industries have been reporting their tax payments in EITI compliant countries where they operate since 2002 and the 2012 Dodd-Frank Wall Street Reform Act now mandates this on a project-by- project basis for US based extractive companies. The EU is considering similar amendments to its Accounting and Transparency Directives, and extending these rules to other industries is a serious possibility.
Of course there’s a big difference between committing to transparency to tax authorities around the world (so authorities in each country have visibility on the allocation of profits and have the opportunity to challenge) and public disclosure of data that may be commercially sensitive, costly to produce and less valuable to the user than a good narrative explanation of taxes paid.
Some civil society organisations want this information from all companies, so that they can draw conclusions on whether the ‘right’ amount of tax is being paid. In the absence of data on this, they have taken a simplistic approach to what they think should be the total contribution. Typically they assume an average profit margin, apply that to territorial sales to find a profit, and then apply the local statutory rate. If the amount of tax actually paid is lower, then the questioning may start.
We have also seen financial analysts looking at effective tax rates when considering investments. If the actual effective tax rate is lower than the estimated rate, then the investor may ask questions to see if the low tax rate is the result of an aggressive tax policy to minimise payments.
Businesses need to work backwards from their market communications. Put simply, if someone were to question the impact of tax on your company’s strategic decisions, what conclusions could they draw from the corporate reporting and publicly available information? And would they be right?
For many companies, it’s time to realise that the questions aren’t going to stop soon.