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Speech by Michael D’Ascenzo, Commissioner of Taxation
Australian Institute of Company Directors
Angel Place Conference Centre, Sydney
18 July 2007
As the saying goes we live in extraordinary times.
The Australian economy is in its sixteenth consecutive year of expansion averaging around 4% GDP growth – a phenomenon quite unprecedented in Australia’s post war economic history. Much of the recent growth is directly or indirectly associated with the mining boom and therefore being driven by the large business sector and the global economy.
In this environment corporate profits have been rising sharply. Both profits and revenue have been growing faster than the underlying growth in GDP.
With growth and a global market place has come increased complexity.For corporates, the challenge is to ensure that this complexity is managed within the company’s overall risk management and governance framework.
The challenge for the Australian Taxation Office (ATO) is to facilitate easier, cheaper and more responsive tax and superannuation compliance arrangements for large business, allowing companies to get on with business, so to speak.
The era of mergers, acquisitions and takeovers
As in past boom times, there has been a sharp increase in takeovers, mergers, and acquisitions, and an increasing use of private equity to fund these arrangements. The larger deals have brought with them the use of new and complex financial instruments.
For Australia, the value of announced merger and acquisition activity in the first six months of 2007 was US$74.026 billion (A$86.3 billion), up from US$30.368 billion (A$35.4 billion) for the same period in 2006 - a 144% change.1
Overlaid on these developments is the fact that large Australian businesses operate in a highly internationalised environment. About 40% of large Australian businesses are foreign-owned multinational enterprises accounting for 32% of the net income tax liability of the entire large market2.
Australia’s exposure to global trade is significant with total overseas trade increasing by 22% for exports and 15% for imports and accounting for 42% of GDP in 2006. Australia has been the fifth largest global recipient of FDI inflows3 over the past decade, accounting for 1.9% of GDP.
With larger trade and financial flows we are entering what some commentators have characterised as an era of ‘banking without borders’.
The contribution of large business
Large business makes a very significant contribution to our tax system.
The top 100 Australian companies are generating 45% of corporate tax revenue. Approximately 1900 large corporate groups (with a turnover in excess of $100 million annually) generate 67% of company tax and 36% of total tax revenue.
These facts reinforce our commitment to creating and maintaining a constructive relationship with large business. Co-operation and trust must of course flow in both directions. In this regard I would like to acknowledge the assistance we have received from large business in developing our new guide, Bribes and facilitation payments: A guide to managing your tax obligations.
On our part we have recently reaffirmed the responsibility of our case managers to bring to the attention of the taxpayers, errors made by them that have resulted in the overpayment of tax.4 Whilst this has been our practice for some time, it is timely to link this approach to the change in our Strategic Statement from the collection of the revenue to emphasising the proper administration of taxation and superannuation legislation. The focus of our activities is to encourage high levels of voluntary compliance and to minimise compliance costs. This in turn is based on high levels of community confidence and trust in us.
The role of directors and board members in tax governance
A key aspect of this strategy is to assist companies in pursuing their interest in good governance. A recent international survey by Ernst and Young5 indicated that the management of tax risk is gaining wider acceptance at the board level both in Australia and overseas. The report notes:
Tax functions globally no longer operate in silos focusing only on tax compliance and managing the effective tax rate. They are increasingly being called upon by board and audit committee members to respond to complex questions about how the organisation manages its tax risk exposure.6
Last year we held a Large Business Symposium with representatives from most of the top 100 corporate groups, together with the Board of Taxation, Treasury and other government officials to explore these and related tax governance issues.
Drawing on the symposium’s outcomes, in January this year I wrote to the chairs of the top ASX 200 enclosing a summary of the publication Large Business and Tax Compliance. The intention was to provide company board members and directors with some suggested common sense questions which they could use for governance purposes. Specifically, we suggested that they make enquiries as to whether their company had:
- a sound framework in place to manage its tax risks and comply with its tax obligations
- a well resourced in-house tax governance capability
- reporting requirements to ensure that significant tax risks could be elevated to the board level7
- appropriate review and sign off procedures for material transactions
- an effective tax risk mitigation capability including the company’s relationship with the Tax Office, and
- a capacity to regularly audit tax governance systems.
Feedback about this initiative from large business has generally been positive.
Compliance focus on company directors – an update
As directors, you have many regulatory responsibilities, not the least being your personal tax responsibilities.
As we announced in last year’s Compliance Program, we have been reviewing the tax affairs of high income individuals with remuneration in excess of $1 million. We have been reviewing remuneration and incentives such as shares, options and rights, cash bonuses, and non-income capital benefits.
Our objective has been to improve our understanding of arrangements, to identify and assess risks and develop strategies to address these risks.
Initial assessment indicated employee share plans were a potential risk.To examine this further, we looked at 1914 public companies (including the top 300 companies). Of these companies, 160 were identified as having employee share plans.
As at 30 June 2007, 601 individuals, who are in the top five highest-paid directors or executives in the above 160 companies were identified as having a possible taxing point under a share plan. Of these 216 have potential discrepancies relating to a cessation time, some over multiple tax years. While there may be various explanations for the discrepancies we are in the process of sending individual questionnaires to a test pool of 30 individuals seeking clarification. More questionnaires are being prepared.
The companies we have examined have share schemes for both executives and general employees.
For executives and directors, who are much more likely to receive rights or options rather than directly granted shares, the key message is that rights and options provided as part of the remuneration package by the employer are income assessable to the individual.
For ’qualifying rights’ (including options) the person will have a choice as to when they are assessed. They can elect in writing to be taxed upfront or wait until cessation occurs in a later year. There are a number of ways cessation occurs including ceasing employment and disposal of the rights8.
However, if they choose to have the shares or options granted to an associate such as their super fund or family trust, it is still included in their remuneration package and the value of the shares or options must be included in their next tax return9.
In addition to the risk at the director or executive level, we believe there may be a broader compliance risk for others who participate in the employee share schemes under review. These employees may be unaware of the special income tax rules and CGT implications of employee share schemes.
When we know more about the nature of the risks involved, we propose to work with representative bodies including the Australian Institute of Company Directors, to co-design appropriate remedial strategies.
Making compliance happen in real time
With the focus on administration rather than merely revenue collection, we are exploring with the market fundamentally new ways in which we can work with large business.
In responding to feedback from large companies we want to better differentiate our approach to corporate groups along the lines of the risk profile adopted by the relevant corporate group. We believe good two-way communication and early identification of tax risks is the way to go. This allows for a ‘prevention is better than cure’ approach for those company groups that are seeking this level of certainty.
One concept we are looking at is to pilot a review of a company’s annual tax return following lodgment to discuss areas of risk.
The benefit we anticipate from earlier intervention is that some issues could be resolved there and then. Some large businesses have expressed a desire to work with us in this way. To this end, we are planning a workshop with them to progress this initiative.
A pilot should prove the effectiveness or not of this approach, and provide an indication of the skilled resource commitments for its wider operation.
Preview of our Compliance Program 2007–08 for large business
Our Compliance Program aims to give timely notice to taxpayers about our compliance focus for the next 12 months, and also to seek your input to the risk choices we have made.
Compliance verification for large business is more intensive than other sectors, because of the complexity of both the transactions and commercial environment and the size of the money flows.
The areas that come within our radar include:
Tax performance at odds with economic performance
In relation to the fundamentals of registration, lodgment and payment, large businesses are generally highly compliant.
However, some businesses are disclosing large accounting profits to their shareholders and the market but returning low levels of taxable income or even tax losses. In these cases, we need to reconcile the accounting profits with the tax outcome, acknowledging that there can be valid reasons for the discrepancy.
Companies with low profits or persistent losses relative to their market share
We will be working closely with large business to ensure their transfer pricing processes and outcomes are in line with the arm’s length principle.
Cases that involve significant increases in the tax value of an entity’s assets when joining a consolidated group, as well as cases involving the exit from a consolidated group will be another area of focus. We will also be paying attention to losses carried forward that do not meet the loss recoupment and deductibility tests, especially when they are transferred into consolidated groups.
Mergers, acquisitions and divestments
As noted, the dollar values of capital restructuring transactions involving Australian-based businesses have significantly increased.
We are closely monitoring the tax implications of this increasing volume of corporate restructuring and refinancing activity, both at the economy-wide level and at the group and transaction level.
The income tax issues we will be examining include:
a. the appropriate use of rollovers, the tax values of significant assets and the utilisation of capital losses, as well as the commercial purpose of the way in which the deal has been structured
b. transactions undertaken by non-residents in relation to taxable Australian property
c. tax planning involving stapled instruments, tax deferred distributions and CGT deferrals
d. capital raisings that involve the use of hybrid securities; including hybrid instruments that may be classified as debt for income tax purposes, but equity for accounting purposes
e. the circumvention of the debt/equity provisions through the use of unit trusts, and
f. examination of the structures used for large infrastructure projects and private equity deals, such as the characterisation and arms length nature of payments to the investors or transaction fees, particularly where payments are made to tax haven entities; compliance with the thin capitalisation rules; and GST compliance on financial supplies and acquisitions.
We will also be examining the role of investment banks and other intermediaries in promoting and facilitating merger, acquisition and divestment deals, along with the appropriate treatment of fees generated.
International arrangements
Global corporate restructures that shift assets, functions and risks offshore will also be reviewed to ensure that they are in accordance with the arms length principle. The use of arrangements between related Australian and offshore entities to shift profits (and tax) from Australia to other countries will continue to come under scrutiny. As part of this we will review the transfer of brand names and mastheads to offshore low-tax jurisdictions and their licence back to Australia. We will also examine transactions and arrangements that involve tax havens and other low-tax jurisdictions, and which appear to artificially reduce Australian tax or generate unintended GST consequences.
We are also concerned about innovative or highly structured financial arrangements that rely heavily on arbitrage opportunities to artificially generate tax benefits in Australia.10
Offshore voluntary disclosure initiative
We are increasing our audit activities on taxpayers who deal with tax havens and try to conceal their income and assets offshore. While not directly related to large business, we have worked with some Australian financial institutions with subsidiaries or branches in countries that are listed as tax havens on this initiative.
Ahead of these audits, I am announcing an initiative encouraging people to come forward and make disclosures of undisclosed income from offshore activities
Taxpayers who contact us before they are the subject of an audit and make a full and true disclosure will have reduced shortfall penalty. The Commonwealth Director of Public Prosecutions has indicated that an indemnity from criminal prosecution may be granted in certain circumstances.
As part of this, I have asked the overseas subsidiaries or branches of some Australian financial institutions to write to their Australian customers in one tax haven, as a pilot, encouraging them to make a voluntary disclosure of unreported income, if required, to the ATO. The financial institution will also provide customers with information on how to make the voluntary disclosure to us. It is expected that their customers will receive these letters in the coming weeks. Later this year we will review the pilot and consider further roll out to other tax havens.
To further encourage voluntary disclosure, the ATO will also be writing to around 1000 taxpayers over the next five weeks where we have information that they have an offshore debit or credit card, issued by a financial institution in the tax havens of Jersey, Guernsey or the Isle of Man, or where they have made a high risk funds transfer identified through the Australian Transaction Reports and Analysis Centre.
I invite taxpayers with undisclosed income from offshore activities to contact us before we contact them. Our website11 has full details about making a voluntary disclosure which reduce statutory penalties, including information on eligibility, how to make a voluntary disclosure, a fact sheet, frequently asked questions, and our ‘Tax havens and tax administration’ publication. Alternatively people can get this information by calling us on 13 28 61.
Conclusion
The necessity of being competitive in the global economy is understandable and to be encouraged. The ATO can make a modest contribution here by minimising the compliance costs of large business. For example, by making it easier for large business to deal with us; by providing greater certainty through binding advice and advanced pricing and forward compliance arrangements; and through more streamlined and less adversarial interventions.
Where the tax law is not operating as intended, we can act as an even handed channel to Treasury and Government, a direct benefit for business where this prompts a change in the law which is to their advantage.12
Large businesses operating in Australia now have greater choice. Given the size and complexity of large business operations, and the global nature of the commercial environment, tax risks will arise. How these are identified and managed through a company’s corporate governance processes, is a matter for each company to consider and calibrate.
By strengthening our relationship with large business, and by being vigilant about tax risks, the ATO hopes to encourage high levels of voluntary compliance with Australia’s tax laws.
The goal of good tax administration is to sharpen rather than blunt business activity. In this regard, I am optimistic about the future.
1 Thomson Financial, Mergers and Acquisitions, 2nd Quarter 2007
2 Analysis of data held in the Tax Office
3 FDI Inflows have grown from US$8.3bn in 2001 to US$24.5bn (estimated) in 2006.
Source: http://www.oecd.org/dataoecd/62/43/38818788.pdf
4 Employee Communication of 3 July 2007: 'The Commissioner has asked for all Active Compliance areas that have direct dealings with taxpayers or their agents to be overt in formally notifying them of any errors...which have resulted in the overpayment of tax.'
5 Ernst and Young, Tax risk: External change, Internal Challenge-the Australian perspective: Global Tax Risk Survey 2006-2007, March 2007
6 Ernst and Young, Tax risk: External change, Internal Challenge-the Australian perspective: Global Tax Risk Survey 2006-2007, March 2007
7 Ernst and Young's survey of companies in 14 major economies showed that 77% of the Australian respondents reported a well established communications channel between their boards and their tax department. That compared with 62% for the USA and 70% overall.
8 An election (under section 139E) to be taxed upfront on qualifying shares or rights must be in writing, in the format described in Taxation Determination TD 97/23, and must be made before lodging the tax return for the year of grant.
9 Our Taxpayer Alert 2007/4 deals with an arrangement to divert the value of shares, rights or options to an associate.
10 As part of our contribution to the international collaborative efforts we will share information with other revenue authorities and undertake coordinated, simultaneous audits where appropriate.
11 www.ato.gov.au.
12 Even the converse ultimately benefits business by providing a more coherent and less distortive tax system where unintended loopholes are identified early and corrected. I encourage business leaders and tax professionals to consider whether openness and transparency in relation to such matters may be both in their long term interests and in the interests of a competitive tax system.
Last Modified: Wednesday, 18 July 2007
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