Hector Thompson, Deputy Commissioner, Public Groups and International (International)
Speech delivered to the 11th Annual Pacific Rim Tax conference
16 May 2022
Good Afternoon, it is a real pleasure to have the opportunity to participate in this conference and I would like to thank the Pacific Tax Policy Institute for the invitation.
This year will be the first time I have attended in person – we will have to see how it stacks up compared to last year when, I joined you from my study at 8.00am on a Saturday morning. The Australian experience of COVID-19 has been a remarkable success from a public health perspective, although it has meant some pretty tough restrictions on international travel. It is great to have the opportunity to be here in person as part of a tax discussion centred on the Asia-Pacific region. While discussions about international tax are synonymous with the OECD, the world’s economic centre of gravity is gradually shifting towards the Asia-Pacific. Events like this are an important opportunity to share observations about global developments in tax in the context of what we are seeing in our region.
I have been asked to focus on two topics for the conference, the large business tax gap and the implementation of Pillar Two of the Two-Pillar Solution to address the Tax Challenges Arising from the Digitalisation of the Economy – the Global Anti-base Erosion (GloBE) rules.
Before I do, I should note that the Australian Government is currently in caretaker mode ahead of this weekend’s election and so my comments are from a purely administrative perspective and will not go to policy. In particular, while both major parties in Australia have indicated that they support the ongoing development of the GloBE rules, neither have yet to set out a detailed implementation plan.
GloBE rules
A key objective of the of the GloBE rules is to provide the community with greater confidence that large multinational companies are paying the right amount of tax in the right jurisdiction.
If you take a long-term view of these things, this shouldn’t be very surprising. We have seen big changes in the global economy over the last 20 years. For much of the last one hundred years, most business models were decentralised – functions, assets and risks were generally onshore where customers were located.
More recently though, multinational enterprises have centralised for a range of reasons including to achieve economies of scale, specialisation, or cost efficiencies. This might involve centralised funding, intangible ownership, research and development, manufacturing, and risk management functions in one entity. This has driven an increased need for cross border activities and increased functional integration between separate legal entities. In turn this created more opportunities to shift profits to low tax jurisdictions and digitalisation has accelerated these trends.
The OECD’s 2020 Corporate Tax Statistics publication highlights that investment hubs account for 25 per cent of global profits of multinationals, but only 4 per cent of employees and 11 per cent of tangible assets.
BEPS 1.0 started us down a path of a more ‘multilateral’ approach to thinking about tax. Examples include the development of a multilateral instrument to amend tax treaties, greater exchange of information between tax administrations through country-by-country reporting and requiring greater attention to transactions ‘beyond the border’ like the hybrid mismatch rules. I would contend that the GloBE rules are a natural extension of this approach.
As with BEPS 1.0, I see both a challenge and an opportunity for multinationals with the GloBE rules. The challenge was covered nicely in this morning’s sessions and is certainly not one to be taken lightly – the opportunity is to re-examine tax supply chain structuring to book profits in jurisdictions where activities are occurring. In addition to the reducing the risk that the GloBE rules will unexpectedly apply; this approach has the benefit of increasing community confidence that the right amount of tax is being paid in the right jurisdiction.
From an administrator’s perspective it is still early days. As mentioned earlier we do not yet have full, agreed details around implementation of the GloBE rules and the OECD is aiming to complete this by the end of 2022. Tax administrations are actively involved in these discussions.
Obviously, the headline issue is the role that financial statements/accounting play in the GloBE rules. It is perhaps the main difference between the new rules and much of the existing international tax architecture. So, it will not surprise you to hear that the ATO is thinking about our capabilities and systems. I expect many of you are doing the same. We will need people with expertise in deferred tax accounting and we will need them at a time when their skills are very much in demand in the market - always a challenge.
Similarly, the GloBE rules envisage a separate return which will require new systems around lodgment, assurance, and compliance. The commentary does a good job of setting out why the GloBE rules rely on firms accounts to the maximum extent possible. It highlights that this is not a typical direct tax on income, more an international alternative minimum tax. As such, it seeks to minimise compliance costs by drawing on information and accounting systems that firms already use for other purposes. But as we have already heard, there are a lot of details for multinationals to work through – where is the information held, who will report it, in what form, what adjustments need to be made and so on.
The other thing we are giving thought to is how we can support the Australian market in adapting to the new rules. It is too early to offer a definitive view because our approach will be guided by the OECD’s implementation framework and domestic legislation.
That said, we would expect to leverage our existing assurance mechanisms such as justified trust, where we engage intensively with the largest multinationals active in the Australian market. Once the ATO is in a position to do so we will start to consult around the sort of public advice and guidance that multinational groups would find most useful.
I know from feedback to date that safe harbours are one of the key areas that many multinationals would like the OECD to prioritise to get a better sense of when they may be able to avoid the effective tax rate calculation (ETR) and top-up tax calculation in respect of its operations.
A number of simplification options, including leveraging off country by country reporting data were flagged in the Pillar 2 OECD Blueprint and it remains to be seen whether these options will be pursued as part of the implementation framework and what form any safe harbours will take.
The operation of safe harbours is set out in the model rules and commentary. Article 8.2.1 allows a filing constituent entity to make an election that would exempt the multinational group from the need to compute a jurisdictional ETR and thus allow a tax administration to deem the top-up tax for the constituent entities located in the safe harbour jurisdiction to be zero. Article 8.2.2 and 8.2.2 (b) provide for a framework for tax administration to challenge a taxpayer’s election to apply a GloBE safe harbour in certain circumstances.
But there is still much for the implementation framework to consider – from fairly technical matters such as the date on which the review period is considered to start and the consequences if the GloBE Safe Harbour is found not to be applicable. As well as the main question – what are the safe harbours? While I expect the safe harbours are probably key for many, I thought it would be useful to outline two other administrative issues that are front of mind for us.
The first is that the GloBE rules place an obligation on the constituent entity to file a GloBE information return with the local tax administration. This will be a significant undertaking.
The return can be filed directly by each constituent entity with its local tax administration or through a designated filing entity. The commentary notes that the constituent entity might not be best positioned to collect the required information to complete the GloBE information return, particularly if most of the information is concerning other members of the group.
In many cases, it is expected that it is the ultimate parent entity, or designated filing entity appointed by the multinational group would be in a better position to collect such information. The commentary also highlights that where this happens it is anticipated that most tax administrations will receive GloBE returns through an annual automation exchange of information process.
This will be done through a bilateral or multilateral agreement between competent authorities to be developed as part of the implementation framework and is expected to be based on the Convention on Mutual Administrative Assistance in Tax Matters. It will need to develop appropriate competent authority agreements, agree on technology used to exchange the information and develop schemas to standardise the information exchange.
The commentary highlights some of the work that remains to be done on filing obligations through the implementation framework. It notes that the information in the GloBE return can be further specified, expanded, or restricted by the implementation framework. It also notes that the GloBE information return may contain other information necessary to carry out the administration of the model rules.
The second administration issue that is attracting considerable attention is rule co-ordination. The GloBE rules are intended to be implemented as part of a common approach. A jurisdiction that joins the common approach is not required to adopt the GloBE rules, but, if it chooses to do so, it agrees to implement and administer them in a way that is consistent with the outcomes provided under the model rules and commentary.
To ensure coordination, the mechanics of the rules result in a country respecting the GloBE rules of the other country, in terms of priority for application and/or calculating various amounts. A key part of this is that other country’s rules are ‘qualified’. This takes me back to my opening remarks – that increasingly tax administrations are being asked to look beyond the border at the tax rules in other jurisdictions.
The main one is obviously the idea of a qualified income inclusion rule – essentially whether the domestic law of a jurisdiction is implemented and administered in a way that is consistent with the outcomes provided for under the GloBE rules and commentary. But there are other ‘qualified’ rules to consider – a qualified minimum domestic top-up tax, a qualified imputation tax (a key one for Australia), a qualified undertaxed payment rule and a qualified refundable tax credit.
I’m not going to run through each of these today, but rather make the point that, subject to the implementation framework process, this looks like an area where we can expect interest around advice and guidance.
Today my key message on the GloBE rules is that there remains much to be done and that consultation with the OECD and between tax administrations and multinational groups is key. So, discussions like those that we are having today are invaluable.
Tax Gap
The ATO’s work around tax gaps has more in common with the GloBE rules than you might think – both are linked to a general sense of unease in the community about whether large multinational companies are paying the right amount of tax.
Over the last decade the Australian Government has acted to tackle corporate tax avoidance in a variety of ways, including additional funding for the ATO led Tax Avoidance Taskforce and the rapid and pragmatic adoption of a range of the BEPS 1.0 measures, including a multinational anti-avoidance law, a diverted profits tax, anti-hybrid rules, country by country reporting and stronger transfer pricing rules.
It is worth noting that although community attitudes have shifted a little as a result, community confidence surveys still indicate that less than half of Australians believe that large companies are paying the right amount of tax. While there have been many high-profile audit cases settled in recent years, these are a bit of a double-edged sword because when people hear about them, it is not always clear whether this means that the problem is under, or out of, control.
One thing that has become clear – traditional reporting of the tax system, with a focus on revenue collections and audit yield are not a very effective way of answering questions about health of the system. A high audit yield could indicate a healthy system with high voluntary compliance with the non-compliance being obvious and caught. But it could also indicate the opposite, low voluntary compliance with only the most egregious non-compliance being caught. Total revenue collections are an even less helpful indicator of revenue authority performance because broader economic impacts tend to swamp the compliance efforts of an administrator in any given year.
That is where tax gap comes in - by trying to quantify the non-compliance behaviours across the whole system, rather than just focusing on the bits we observe directly. I should of course give my IRS colleagues a nod here, they pioneered the approach of measuring tax administration performance using a large-scale random audit program which has evolved into the tax gap programs we know today. Since then, other jurisdictions such as Australia, Canada, Denmark, Sweden, and the United Kingdom have produced estimates and are all now part of the OECD Tax Gap Community of Practice.
We began our foray into estimating and publishing tax gap estimates in 2012, by releasing our VAT (goods and services tax) and luxury car tax gaps. GST represented a sensible starting point for the tax gap program given its broad-based nature and readily available data. Since then, we have released gap estimates across a complete range of taxes and programs.
The latest published estimate of the large corporate tax gap is for the 2019 financial year. It suggests a gross gap of 8.3 per cent and a net gap of 4.3 per cent. Broadly speaking, gross gap refers to the amount voluntarily reported to the ATO at lodgment, while the net gap includes amendments made as a result of compliance activity. If we are talking dollars, then the large corporate tax gap suggests that of the roughly $55 billion we think is due, around $51 billion is paid voluntarily and another $2 billion is raised as the result of compliance activities.
This analysis goes some way to answering the question, how big is the problem and how effectively is it being addressed? But it is also useful to contrast it with the individual tax gap. After all, it is individuals who answer surveys about whether large companies are paying the right amount of tax, so it is fair enough to ask how individuals are performing!
As it turns out individuals do indeed have a lower gross gap. In 2019 it was 6.1 per cent, although the net gap was actually higher at 5.6 per cent. Put another way, individuals have higher voluntary compliance, and our compliance activity is less significant in terms of the proportion of additional revenue it raises. Perhaps this goes some way to explaining the answers to those surveys.
That said, the performance of the large corporate market has improved since we started producing our large corporate gap estimate. Our 2014 estimate suggested a gross gap of 10.4 per cent and a net gap of 6.2 per cent. Looking forward our goal is to achieve a gross gap of 4.0 per cent and net gap of 2.0 percent cent. By looking closely at the gap, we can start to get a better picture of how sensitive the gap is to our action over time.
Our estimate of the large corporate market is that they currently pay around 96% of the amount of tax they should pay (i.e. a 4 per cent net gap), but only after compliance activity. So, the system is not far off our aspirational target of 98% (i.e. a 2 per cent net gap). Our estimate also suggests that if we reduced our investment in compliance in the large market then the 96% figure would fall back toward 92% (the 8 per cent gross gap). This enables us to think about what a ‘tolerable’ gap might be for large business market.
It also frames our strategies to address tax avoidance – profit shifting remains our key risk. This might be through transfer mispricing or artificial contractual exclusion of risks and rewards because Australia has a high statutory corporate tax rate and is a capital importer these risks are ever present. This means to achieve our aspiration we need to maintain a strong focus on combatting profit shifting. We focus on a range of strategies. While litigation tends to dominate in the press, we also focus on setting precedents through our settlements, promoting transparency through practical compliance guidelines, focusing on the role of advisers, and encouraging multinationals to think about tax as the silent ‘T’ in environmental, social and governance factors.
In terms of what a ‘tolerable’ gap might be there is obviously considerable judgment involved. Australia’s tax gap in 2014 and the Corporate Tax Avoidance Inquiry suggest that voluntary compliance of less than 90 per cent is outside of tolerance. It is also important to recognise that perceptions of performance in the large market have spill over into other markets.
One interesting observation is that our aspirational target is largely about achieving higher voluntary compliance and would mean less audit activity than today (or in 2014). This makes sense it you are trying to provide the community with confidence that multinationals are paying the right amount of tax.
Thank you for your time today, it has been a pleasure to meet many of you in person and I look forward to our ongoing discussions.
Speech by Deputy Commissioner Hector Thompson at the 11th Annual Pacific Rim Tax Conference in Redwood City, California on 16 May 2022.