The global tax environment: challenges for multinationals

For multinationals, the need to operate in many locations makes tax management especially difficult, and just complying with the tax laws is far from easy. The main problem is the large number of laws and regulations to consider, and the accelerating pace of change.

There were literally thousands of tax law changes around the world from 2009 to 2010. In the U.S. alone, sales tax rates were adjusted in 850 different tax jurisdictions. In Brazil, where there are over 5500 tax jurisdictions, hundreds of sales tax rates were modified. In these and other countries, policy changes have affected income taxes, VAT or goods and services taxes (GST), payroll taxes, customs duties and special sales taxes (like Taiwan’s commodity tax), environmental taxes, property taxes, and so on. If you include additional complications, such as court rulings in tax cases and changes in how revenue agencies administer tax collection, the collective impact on tax management is truly enormous.

Although technology offers tools companies can use to maximize cost effectiveness and achieve the best tax rates globally (enterprise resource planning systems, or ERP, for example, include tax functions), the sheer number and extent of changes in global tax regulations make it hard for multinationals to handle their tax situations on their own.

Most of the pressure bearing on the corporate tax work environment stems from obligations to comply with the regulations of multiple tax agencies. Corporate tax leaders must keep pace with changes in tax regulations and tax rates wherever they operate. Applying technology to established tax regulations can provide considerable assistance to tax managers, but they must still contend with the large number and frequency of changes being made to those regulations. Indeed, the pace of change is still rising. As tax authorities become increasingly strict in how they assess and collect taxes from corporate taxpayers, the ‘strict supervision’ approach creates major tax management challenges for multinationals.

Global tax challenges

The U.S. has indicated that it intends to adopt IFRS as its reporting standards as early as 2014. U.S. subsidiaries that have come to rely on their information systems to produce financial statements must respond carefully to any impact IFRS may have on their overall operating procedures, information systems and of human resource allocation. They must also make an early assessment of the tax risks from introducing IFRS, draw up effective plans and carry them out cautiously. And while many multinationals engage in trade or business activities in the U.S. through a permanent establishment (PE), as opposed to a subsidiary, the IRS is already appointing additional tax experts to assist in auditing multinationals’ PEs in the U.S.

National tax authorities are pursuing tax system reform and pressing harder for strict compliance with tax regulations, driven by changes in the external tax environment, changing economic and business conditions, and heightened demands from governments for tighter tax management and additional revenues. This shows up, firstly, in unabated transfer pricing disputes and negotiations. Secondly, nationwide audit approaches are on the rise among tax agencies around the world. (Representative approaches include the Netherlands’ ‘Tax Control Framework’ and Ireland’s ‘Cooperative Approach to Tax Compliance.’) These schemes may translate into yet more work for corporate tax departments already burdened by the changing tax environment, and they are part of a global pattern of change:

• The U.K. has introduced rules requiring senior accounting officers to take personal responsibility for their companies’ tax accounting arrangements.
• The EU’s broad package of VAT simplification measures, implemented in 27 member countries, will impose considerable costs on multinationals in the short term, though it promises to yield benefits down the road.
• India is implementing a two-stage GST system in 2011 to replace over ten existing indirect taxes. In the long run, corporations will benefit from this tax reform, but in the short run it will cost them substantially in terms of tax management, information technology resources and outside consulting costs.
• Malaysia is set to implement a GST in 2011, in this case to replace sales taxes.
• China intends to eliminate its business tax by bringing it within the scope of VAT taxation. The current business tax is levied on sales of services, transfers of intangible property, and real estate sales. Since the business tax rates are generally lower than the standard VAT rate, the switch to VAT will mean applying higher rates, increasing companies’ tax burdens and operating costs.
• The Gulf Cooperation Council countries (Saudi Arabia, Bahrain, Kuwait, Oman, Qatar and the United Arab Emirates) are preparing to implement a new GST system within two to three years. This will be the first time a broad-based value added-type business tax has been instituted in the Middle East.

In addition, governments everywhere are using environmental taxes, carbon taxes, carbon emissions trading and other methods to raise revenues, opening up new sources of uncertainty for multinationals over their tax burdens. These new forms of taxation add to firms’ costs, forcing them to look for solutions.

Clear trend emerging from the changing tax environment

Bilateral tax agreements and information exchange networks incorporating OECD standards have become fairly common, with the number of recently renegotiated tax agreements approaching the 100 mark. The OECD and WTO have been working together to promote international coordination on taxes. Meanwhile, the OECD-led dialogue on corporate restructuring may also show results in the near future. Over 3o member countries have already adopted new regulatory compliance rules.

In the past, companies could file taxes in either soft or hard copy. Now, they are more likely to be required to file electronic returns, as this enables tax authorities to audit tax filings electronically as well. Some countries already use statistical sampling audit as their principle audit tool. This method is likely to be widely adopted by national tax agencies, so tax professionals must have the technical competence to meet the associated tax management demands.

For corporate tax departments, the trend in tax management is quite clear, and it means that workloads are set to increase a great deal. In many instances, corporate tax departments are unable to achieve their objectives when they are forced to handle major tax management cases without additional resource support. Such cases are not the sort that corporate tax department personnel can resolve quickly, so firms must make sure to document them thoroughly and resolve them with care.

These are just a few of the pressing compliance challenges facing multinational tax departments. Beyond meeting these challenges, tax departments must also develop plans for implementing their firm’s global tax vision.

Demands on corporate tax departments growing

Bound by cost management pressures and resource constraints, corporate tax departments’ ability to play their tax management role effectively is deteriorating at an accelerating rate. Corporate tax professionals are being asked to do more tax management work with fewer resources, and ‘normal’ is now seems to be defined as unrelenting toil.

Companies need to go beyond tackling information technology problems and redouble their efforts to develop in-house tax talent. It is quite difficult to recruit talent with tax management backgrounds, especially in international tax management. Experts on transfer pricing, tax withholding, customs duties, commodity taxes, VAT or GST are even scarcer. In fact, the staffing problems of corporate tax departments have persisted for years, as younger generations tend to feel that corporate tax management is an unglamorous field. As a result, corporate tax managers tend to be older, with many approaching retirement age, and filling senior tax management positions is seldom easy. Unfortunately, this situation is not going to improve in the near future, so corporations will continue to suffer global tax management staffing headaches.

Cross-border M&A deals are a natural consequence of globalization and the need to pursue regional business strategies, with the result that tax teams must shoulder new and unfamiliar tasks. This creates major challenges for maintaining tax law compliance and controlling costs. During the recent worldwide recession and subsequent recovery, some multinational groups were quick to absorb or merge with troubled companies, becoming bigger enterprises in the process. Even now, healthy companies are vulnerable to hostile takeover bids if their share prices weaken. These cross-border M&A involve additional tax jurisdictions and different cultures, tax rates and regulations that will have to come under multinational tax management, adding to the pressure on corporate tax departments.

The global financial crisis led predictably to lower tax revenues, so to boost tax collection, most national tax agencies have tightened their supervision, with audits covering tax avoidance as well as illegal tax evasion. In recent years, tax agencies around the world have been expanding the scope of legal compliance in order to safeguard tax revenues, and of course they hold the upper hand in the perpetual struggle between tax collectors and taxpayers. By establishing information exchanges and bilateral tax agreements, vigorously promoting tax information transparency, and introducing anti-tax avoidance legislation, they have effectively reduced incentives for avoiding and evading taxes, but this clearly puts more pressure on corporate tax departments.

The number and frequency of tax regulation amendments in different countries increases uncertainty with respect to tax burdens, thus posing a major challenge to corporate tax departments. Another development is so-called ‘moralistic’ legislating, which relies on moral legitimacy as opposed to legal sanctions to dissuade large companies from using tax planning to shirk their taxpaying obligations. When managers at multinationals decide important tax payment matters, moreover, they must bring possible future legislation into consideration.

Corporate tax management in an era of strict supervision

In recent years, corporate tax management personnel have found themselves in a tax-regulatory environment characterized by increasingly rigorous supervision, and this trend shows no sign of abating. Under these circumstances, the sense that tax agencies’ demands may have become excessive has gained currency. As a result, tax agencies and corporate taxpayers have come together in some advanced countries to alter the pattern of corporate tax administration, throwing out the traditional approach – audits of books and records – in favor of more strategic, higher-level tax risk audits.

The basic premise of the new approach is consistent recognition by both the tax authority and the taxpayer, with corporations required to establish and maintain certain controls and management procedures, which are then subjected to relatively loose examination. The theory is that corporations must allocate costs and resources sufficient to maintain reasonable standards of tax code compliance. Currently, only a few countries can be considered leaders in this area, so there is much room for improvement. Before corporations can reap benefits from changing the system, however, there are a number of changes they must make themselves. For example, they must:

• convert internal tax information search and maintenance into outsourced data management;
• adopt an automated tax payment system for accounts payable and receivable, in place of the current practice whereby staff choose which tax law provisions to apply;
• switch from detailed and invasive tax audits to audits of the risk management arrangements;
• go from relying on information technology for the production of financial statements to using business intelligence and reporting tools accessible by tax experts; and
• have suppliers maintain a tax planning search engine instead of establishing and maintaining tax rules in the main ERP module.

Conclusion

Uniformity of tax regulations in countries around the world would greatly simplify tax work for multinational corporations, but can it be achieved? In the short term, the difficulties appear insurmountable, but in the longer term, the ideal should not be considered beyond reach. If the OECD, the UN, the World Bank and IMF act decisively on global tax management, laying down reasonable guidelines and leveraging the latest technology, then considerable progress could be made in that direction. International tax coordination would improve tax policy, and it would also boost tax revenue, which is, after all, what enables governments to provide services to their people.

Multinational corporations have long relied on technology to deal with complex problems. The problems of international taxation are no exception, so it is inevitable that multinationals will tend to automate tax management work. For years now, many companies have relied on the tax functions in ERP systems. Without human intervention, however, such systems cannot integrate changes in tax rates, regulations and logic. Clearly then, multinationals require a more advanced automation system before they can fully meet the management challenges of today’s complex and rapidly changing global tax environment.

(This article was completed with assistance from Joseph Wu. It originally appeared in Tax Journal, Vol. 2116, on 10 July 2010.)