Speech by Michael D’Ascenzo
Commissioner of Taxation
Deloitte Academy
Melbourne, 16 April 2007
The importance of large business to Australia
You probably know the demographics of the large market (businesses with an annual turnover of around $100 million or more) better than me. There are about 36,200 entities totalling approximately 1900 corporate groups in this market. In the corporate population, 41% are foreign-owned multinational enterprises, accounting for $280 billion in total gross profits (around 55% of the large market profits).
Total large market revenue collections including income tax, pay as you go withholding (PAYG(W)), petroleum resource rent tax (PRRT) and fringe benefits tax (FBT) have increased from $61.5 billion in 2003-04 to $75.1 billion in 2005-06.
The top 100 corporate enterprises contributed 67% of corporate income tax collection, the next 100 companies contributed 9% and the next 400 largest companies contributed 11%. Similarly, the top 100 companies account for 79% of PRRT, 41% of PAYG(W) and 42% of FBT.
These figures highlight the role of Australia’s corporates as major contributors to the nation’s overall revenue collections and prosperity.1 This would not happen without a high overall level of voluntary compliance with Australia’s tax laws. For example, Australia has the highest corporate tax outcome on the OECD-10 at 5.3% of GDP compared with an unweighted average of 3.4%.
Transparency and trust
Given the critical role played by the corporate sector to Australia’s wellbeing, it is important that the administration of the tax laws provides a support role rather than an impediment to business. The Australian Taxation Office (ATO) believes that this is best achieved through a close and constructive relationship based on transparency and trust.
We have seen a greater preparedness on the part of large business to openly engage with the Tax Office and we will continue to do likewise.
The positive feedback on our Large business and tax compliance booklet, the Large Business Symposium held in August 2006, our formal program of dialogue with the Top 100 corporate groups and the signing of two forward compliance arrangements (FCAs) with ANZ and BP are signs of a healthy relationship. I also wrote to Chairs and CEOs in January this year enclosing a one page summary of matters they might want to take into account as part of their corporate governance and have received positive feedback from a number of Chairs and CEOs as well.
To maintain the momentum on what we have achieved so far, I’m looking to continue working with large business to identify new administrative approaches to reduce compliance costs and increase certainty for large business – increasing certainty in uncertain times is surely a good thing.
Managing risks
Every large organisation, including the Tax Office, has to manage material risks to its performance and reputation. Better management of risks can lead to more certainty around the achievement of business objectives, which in turn can increase returns for the organisation’s stakeholders, whether they are shareholders, or the broader community and the government in the ATO’s case.
Increased activity within global markets by Australian companies is generating transactions that reflect a dynamic business environment. The growth in the value, volume and complexity of these transactions can create governance and administrative challenges for large corporates and for the Tax Office. We continue to make large adjustments through our audit work, indicating an ongoing need for vigilance on our part and care on your part.
We believe it is critical for us to develop a close and constructive relationship which provides the Tax Office and large corporates with an understanding of these risks and avenues for their mitigation. Even where we agree to disagree, the aim should be to efficiently and properly resolve that difference in a way that strengthens rather than diminishes trust and mutual respect.
As you know, we have been promoting the idea that a large corporate’s risk management framework should extend to material tax risks.
Leading tax advisors tend to agree with this notion. A global survey of corporate tax directors and other senior financial executives conducted by Ernst & Young from May-July last year showed that leading tax functions are integrating tax risk management with an enterprise-wide approach to risk, implementing systematic processes and controls to prevent or detect potential tax risks across all areas of the organisation.2
The same survey also found that managing tax risk continues to be one of two leading measures of performance of tax leadership, alongside the accuracy of tax accounts and disclosures included in financial statements.3 These results were the same for both Australian and global respondents, representing a dramatic shift in the focus of most corporate tax departments from traditional measures such as timeliness of compliance and effective tax rate planning.
A recommendation of the 2006 Large Business Symposium was to provide a one page overview of our Large Business and Tax Compliance booklet to assist you in your corporate governance responsibilities. Accordingly, my January letter was provided to you in this context. An even shorter version of the summary could be as follows:
- Does the company have in place a sound framework for managing its tax risks and complying with its tax obligations?
- Is there a well resourced in-house capability in place, with appropriate skills and experience?
- Are there appropriate reporting requirements in place to ensure that significant tax risks are escalated to the board (or one of its sub-committees) in a timely fashion?
- Are arrangements in place to have appropriate review and sign-off for material transactions?
- What measures does the company adopt to mitigate risk (such as rulings, advance pricing agreements in transfer pricing, external opinions), and what is the company’s relationship with the Tax Office?
- Are these systems and processes audited regularly to ensure that they are operating effectively?
The feedback on the one page summary has generally been positive. For example, one Chair kindly responded in the following terms:
The management team at [ ] adopts a rigorous, structured approach to regulatory compliance risk, including tax matters...The Board is satisfied that this structure is operating effectively to bring key issues to its attention. Notwithstanding this process, your letter and the accompanying booklet are a timely reminder for the [ ] Board that tax issues remain an important element of our ongoing compliance obligations.
In respect of major transactions, the Board takes a keen interest to ensure that tax positions being taken are in accordance with the law. This often involves seeking independent tax advice from professional advisers or the ATO. In this respect, it is pleasing that [ ] management received recent helpful support via the ATO’s Private Rulings process... Meetings are held between [ ]’s tax department and your senior officers at least twice each year as a forum for encouraging a cooperative approach to compliance. That opportunity for discussion is welcomed.
Identifying tax risks
It is in everyone’s interests for there to be no surprises. With this in mind, we share with you those areas of potential risk that are within our radar.4
Without being exhaustive, in 2007-08 we will focus on:
- Corporate restructures, mergers and acquisitions;
- Financing arrangements including the use of hybrid securities and
- Companies whose tax performance is at odds with economic performance.
The value of deals associated with mergers and acquisitions in 2006 could be significantly more than that seen in 2005 and value (including both debt and equity funding) of domestic leveraged buy outs rose sharply in 2006.5
We are increasingly working with business to understand the commercial underpinnings for the structuring of the deals. As part of our review, we would check that capital gains tax outcomes on divestment are appropriate; compliance with the thin capitalisation rules; whether any increased capital allowance deductions reflect any increased tax value of assets on acquisitions; whether the use of carry forward losses comply with the loss rules; and that any payments to overseas related parties are at arm’s length.
Similarly, major financing transactions would be reviewed to consider their compliance with the debt/equity and thin capitalisation rules. Tax planning involving unit trusts, stapled instruments, tax deferred distributions and CGT deferrals in relation to unstapling hybrid instruments would be subject to close analysis.
In 2005, 68 per cent of large market groups reported transactions with offshore affiliates (either a parent company or a subsidiary). This activity explains our ongoing focus on transfer pricing issues.
When the environment is dynamic and arrangements are complex, potential tax risks will arise. However, this should be put in context of an increasing tax to profit ratio for virtually the whole of the large corporate market since 2001, with the weighted mean tax to profit ratio at around 25% in 2005 and 2006. Nevertheless, it is important for both large corporates and the Tax Office to understand potential risks and avenues for their mitigation.
Increasing certainty
We would like to move away from an adversarial relationship to one that is more constructive and collaborative.
We have for over a decade engaged with companies to work out advance pricing agreements on transfer pricing matters, and we will continue to do so. This complements our system of binding and reviewable private rulings which makes the tax system more certain for taxpayers.
Two years ago, we introduced more streamlined private ruling processes to assist companies with their corporate governance. This has resulted in significantly shorter response times, built on early discussions and full disclosures of the proposed arrangements, as well as an organisational focus.
Last year, we signed two forward compliance arrangements (FCAs) with the ANZ6 and BP.7 They promote governance arrangements that reduce the company’s risk of audits, tax litigation, penalties and interest, and also streamline access to support and advice. However, FCAs are a premium product – they require high standards of taxation self examination and continuous disclosure and so may not be for everyone. We are working with the Corporate Tax Association to develop less rigorous approaches that provide more graduated levels of certainty for large business – options that are also concomitant with your appetite for risk.
These could include proposals based on full and true disclosure of the elements of a proposed or completed transaction; or they could be based on disclosure of any reasonably arguable (contentious) position adopted by the company, in both cases protecting the company from any culpability penalty.
Reducing compliance costs
It is important to remember that the ATO administers the tax law, we are not the policy makers. Nevertheless, where in practice the law does not reflect that policy (whether to the benefit of the taxpayer or to the benefit of the revenue), or where the compliance costs of a measure are excessively high, we would (usually through Treasury) advise government accordingly. The opportunity exists therefore for collaborative approaches in these circumstances. We are also prepared to consider practical ways to reduce your compliance costs by aligning tax administration as closely as possible with existing business and accounting practice.
We are strong supporters of the Government’s initiative to reduce compliance costs for business through standardised business reporting.
Conclusion
Large business plays a critical role in the efficient and effective operation of Australia’s tax system. Recognising this, it is important to nurture an environment that values consultation and co-design, open dialogue on how the tax system is working in practice and which provides opportunities for improvements to the system and its administration. By working with large business, we hope to co-design approaches that both minimise your costs and allow companies to get on with business and add value to their shareholders and to the Australian community.
Given the increasing importance of the business friendliness of our tax system in the competitive global environment, I hope that you find the ATO’s emphasis on consultation, transparency and innovation is a very encouraging development.
Footnotes:
1 See also Business Council of Australia, Tax Nation: Business Taxes and the Federal-State Divide, April 2007
2 Ernst &Young, Tax Risk: External Change, Internal Challenge: Global Tax Risk Survey 2006, December 2006.
3 Ernst & Young, Tax Risk: External Change, Internal Challenge - The Australian Perspective: Global Tax Risk Survey 2006-2007,, March 2007.
4 These are published in our annual Compliance Program, and for large corporates are updated on our Large Business and Tax Compliance site on our website, www.ato.gov.au.
5 Reserve Bank of Australia's February 2007 Statement of Monetary Policy.
6 On GST.
7 On GST and Excise.
Last Modified: Tuesday, 17 April 2007
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