There is growing focus on improving transparency and trust when it comes to tax matters. These topics are increasingly being incorporated into general ESG reporting and both the OECD and EU are looking at new measures in this area involving increased reporting obligations for taxpayers. There are also initiatives designed to improve trust in the tax system, with an upcoming legislative proposal on “shell companies” designed to tighten up substance requirements, which has renewed political impetus in the wake of the recent Pandora papers revelations. What do industrial clients need to know?
The tax world is changing rapidly, with major developments around the taxation of multinationals, and a growing number of initiatives around hot topics such as transparency and the environment.
In this second blog in our series aimed at the industrials sector, we consider another continuing trend in international tax, which is an increasing focus on improving transparency and trust.
Whilst recent proposals at an EU and OECD level to increase transparency and the exchange of information on taxpayers are not targeted specifically at industrial clients, they could apply to them, nonetheless.
The most important current initiatives are either aimed at making more tax related information available to the public (such as public country by country reporting and the upcoming EU initiative on publishing effective tax rates), or at making more information available to tax administrations, which can in turn share such information with other tax authorities within the EU or worldwide. Some of these initiatives are still at very early stages, but the scope and potential implications for industrial clients mean that these are worth keeping an eye on. We set out some of the key measures to watch below.
Public country by country reporting
This EU initiative will require large multinational enterprises (MNEs) with a turnover of more than EUR 750 million to report to their local register within the European Union and to make available on their website information including: number of employees, business activities, amount of profit, income tax paid or accrued, turnover including intragroup turnover, and will require them to report information on activities that they have in non-cooperative tax jurisdictions. MNEs that are in scope of this proposal will have to report such information for all their subsidiaries located within EU Member States on a per country basis and, for the rest of the world, on an aggregate level. The first reports under this measure are expected to happen in 2024-2025.
Publishing effective tax rates
Closely linked to the OECD Pillar 2 initiative (as to which see our recent blog here), the EU plans to take some of the progress that has been made at an OECD level and use this to enhance transparency. In addition to a directive implementing Pillar 2, the EU is planning to publish a proposal in early 2022 that will require large multinationals to publish their effective tax rates. The Commission recently indicated that the calculation of the effective tax rates will make use of the methodology agreed for the purpose of Pillar 2. The rationale behind this proposal is to ensure companies do pay at least 15 per cent corporate tax and to help monitor whether the Pillar 2 agreement is having the intended effect.
Further extension of Directive on Administrative Corporation
Under the Directive on Administrative Corporation (DAC), taxpayers have various obligations to report information to EU tax authorities, which is then subject to automatic exchange across the EU. Many will be familiar with the 6th iteration of DAC (DAC 6) which requires intermediaries, including lawyers and other advisers, to disclose information on tax structuring to tax authorities. There are to be two new extensions to these rules. Firstly, DAC 7, which is due to take effect in 2023, seeks to put obligations on operators of digital platforms to provide information to tax authorities about the sellers that operate on their platform. This is in line with equivalent proposals by the OECD in this area (the OECD model reporting rules). Secondly, DAC 8, will require those trading in cryptoassets to disclose information on these trading activities to tax authorities. The Commission is of the view that although digitisation in this area could potentially be an opportunity for fighting tax evasion, to date it has been mostly used by tax evaders to avoid scrutiny by tax authorities. The proposal on this is expected next year.
Fighting the use of shell companies
“UNSHELL” is an upcoming legislative proposal intended to curb the use of abusive and aggressive tax structures. The aim is to ensure that legal entities and legal structures in the European Union that have “no or minimal substantial presence and no or minimal real economic activity” will not benefit from tax advantages going forward. The European Commission’s proposal is expected to be unveiled on 22 December and will then be negotiated throughout the first semester of 2022 by all member states in the Council. France will be leading on this, as it takes over the Presidency of the Council in January. It appears that French representatives are keen to get negotiations moving because of the renewed political impetus around the use of shell companies since the Pandora Papers revelations. There is little detail available so far on the substance of these proposals, but it is likely to involve a real substance test. Entities found to be a mere shell would potentially lose their residence certificate, so this could be a real deterrent from the use of such entities.
Impact on the industrial sector
What does all of this mean for those operating in the industrial sector? All of these initiatives entail an increased compliance burden for taxpayers within the scope of the different proposals. It will be important, going forward, that taxpayers safeguard consistency between all these different reports. Many multinationals already have to prepare reports on financial information and, in some cases, ESG information. Public country by country reporting and publication of tax rates will have to be added to this. Consistency between those reports will be crucial as they will be used more widely in tax audits, not only of the taxpayers in question, but potentially also in relation to other taxpayers. Inconsistencies could potentially lead to disputes and challenges by tax authorities. With more information on MNEs in the public domain, as well as additional scrutiny from tax authorities, there may well be increased attention from activists and the press. Group internal restructurings and preparations for M&A transactions might need to be disclosed indirectly through public country by country reporting if they, for example, affect the business activities or the number of employees a business has in a specific Member State. Going forward, the compliance and reporting burden with regard to taxes might even increase, especially if tax strategies become a more integral part of mandatory ESG reporting and specifics on such reporting are more aligned. Being prepared for these increased reporting obligations will therefore be key.
What else is on the horizon from a trust and transparency perspective?
The EU is increasingly keen to link ESG reporting with tax transparency. It is currently preparing its first ever EU wide sustainability reporting standards (the Corporate Sustainability Reporting Directive), which is being agreed and in the process of being negotiated. It is expected that this would include some sort of tax criteria, potentially a cross reference to public country by country reporting, which would also have to be disclosed as part of the corporate sustainability reporting directive. The European Commission would also like to draw up a social taxonomy to provide information for investors on the social impact of their investments, which would measure whether an economic activity positively supports workers, consumers and communities. One of the criteria to assess whether a taxpayer has a positive impact on communities would potentially be whether it is engaged in transparent and non-aggressive tax planning. This area is definitely one to watch going forward.
For more on the EU Business Taxation for the 21st Century (BT 21) package, see our dedicated webpages here.
A first step for a fairer tax system is a greater public transparency on the taxes paid by large economic actors. There is a growing demand from citizens and civil society organisations to ensure both more transparency and fairness regarding business taxation, in particular corporate income taxation. (from the European Commission's Communication on Business Taxation for the 21st Century.)