2022 has been a significant year for tax professionals.
As the health impact of Covid-19 starts to wane and focus shifts to reducing the residual financial impact of the disease, many global tax authorities are restarting their compliance activities. In particular, tax authorities around the world are increasingly using data as part of their compliance scoping and risk reviews.
The tax landscape continues to increase in complexity both in the UK and globally. While there are some areas of international convergence, most notably global agreement on base erosion and profit shifting, in many other areas the tax treatment of costs can vary significantly.
We are also seeing the rise of green taxation globally, focusing the minds of decision makers to switch to renewable and sustainable production methods. This sentiment is echoed by employees, resulting in a shift to “greener” benefits being provided.
Global Issues, Local Nuances
The issue of global tax differences is not new. Each country has its own tax rules, with corresponding differences in tax rates, reporting obligations and withholding requirements. These global differences can give rise to tax risks that are becoming more pronounced as tax authorities look to increase their tax take by amending tax exemptions and seeking to bring different types of income into the remit of taxation.
One challenge is identifying where a cost’s tax treatment has changed. Where there are administrative changes to local guidance, rather than the introduction of new legislation, which is often better signposted, these changes may fall under the radar and their impacts are not considered.
A significant challenge to in-house tax teams is how to keep abreast of changes in the different countries in which a group may operate. This risk can be mitigated by taking a proactive approach in each country and seeking to engage with local advisers to understand tax changes. However, there is a cost associated with obtaining advice, and therefore it may not be commercial to seek external counsel in every instance. This approach can also mean significant additional work for already stretched teams as they try to keep on top of, and make sense of, changes in multiple jurisdictions.
Specifically for 2022, many jurisdictions are starting to reverse extra statutory concessions introduced in response to the Covid-19 pandemic. The reporting and filing positions taken as a result of these relaxations will need to be carefully monitored as they are removed, particularly in the area of cross-border workers. It is important to ensure that process owners are aware of upcoming changes and processes are correctly altered.
Internal processes also need to be as simple as possible, limiting differences in how employees and suppliers are managed globally. Processes that are not streamlined increase business costs and reduce the speed by which decisions can be made. However, the absence of local processes invariably gives rise to tax risk.
Delivering process efficiency is becoming increasingly vital to businesses and tax functions are required to play their part. A common approach to managing changes in the tax landscape can have a role in achieving this goal—however, the potential risks need careful managing, for example in the UK with Sarbanes-Oxley (SOX) and with the recently enacted requirement for large businesses to notify HM Revenue & Customs of “uncertain tax treatments”.
Technology can be the solution to this dichotomy. Many system providers have components or customizations that cover local tax rules, with the most sophisticated providers having modules that integrate with existing systems. However, technology is often only as good as its users and the quality of the data, so training is required to ensure these tax components are used correctly and the right data captured.
A specific concern for 2022 is the loss of residual knowledge, as global staff turnover has been high: Finance and tax teams have not been immune to this trend, meaning knowledge of technological processes may have left with the departing employees. This is especially a concern where knowledge resides with one or two individuals, so it is essential businesses have detailed process documentation and well-defined policies.
Alternatively, a business can choose to run a single global approach and take a filing position for any differences in legislation. This may be the only solution where commercial benefits outweigh the potential tax liability (including penalties) and no technological solution is available. This approach will depend on a business’s appetite for risk and the number of countries that have bespoke legislation impacting that process.
Finally, differences in global tax rules can impact employee morale. As an example, provided certain conditions are met, a benefit provided to an employee in the UK can be reported within a Pay As You Earn Settlement Agreement. This enables an employer to settle the income tax and social security on behalf of the employee outside of the payroll.
However, in many international jurisdictions, an equivalent reporting opportunity may not be available. This means the benefit needs to be processed via the payroll. Whilst employers can gross-up the cost to settle the income tax and social security on the employee’s behalf, this additional income can impact a number of other areas (for example, the availability of statutory benefits, future withholding rates or spousal tax rates). The impact of this can leave employees feeling they have received a lesser award, as they are financially worse off than their colleagues who did not suffer these negative consequences.
Employees have become used to the increased flexibility in where they work brought about by Covid-19 and, in some cases, this is leading to requests to relocate to a different country from where the employing company is based. Many countries adopted a more relaxed approach to remote workers during the pandemic, but are starting to roll back these temporary relaxations. This presents a unique risk, in terms of permanent establishment and income taxes, which needs to be managed.
On a more positive note, it is clear there is increasing international co-operation on tax administration. December 2021 saw the introduction of an Organization for Economic Co-operation and Development two-pillar solution to reform international taxation rules, which created a landmark minimum tax rate of 15%. Although EU Finance Ministers failed to reach a compromise on Pillar Two at their recent ECOFIN meeting, and resolving the concerns raised by some member states could present a challenge, there are still grounds for optimism that Pillar Two will be implemented in 2023, albeit later than first planned.
There has also been a multilateral framework for tax transparency and information sharing, enabling a tax authority to ask for information from the authority of another jurisdiction in connection with a tax inquiry or investigation. This successful international co-operation can help sow the seeds of future change and ensure greater global alignment in future.
Tax Authority Scrutiny and the Rise of Big Data
The International Monetary Fund reported that in 2020 government debt levels had increased significantly, mainly as a result of the Covid-19 pandemic. Against this backdrop, many tax authorities are restarting their compliance activities. In 2022, a key trend is the increased use of “big data” globally to assess taxpayer risk and drive compliance approaches.
Big data is the analysis of large data sets by tax authorities to reveal patterns and trends. This has been driven by the increased data available for tax authorities from different sources, including digital devices, banks, suppliers, other government agencies, and international partners.
The use of big data has manifested in several trends. The first is the increased use of proactive targeting campaigns, with taxpayers selected based on profiles or other information held by tax authorities.
One example of this in the UK was the tax authority, HMRC issuing “nudge” letters to individuals who hold, or were known to have held, investments in cryptoassets. The letter reminded them of the capital gains tax consequences of their gains. There are also examples in Italy, where the Italian revenue agency used data from multiple sources to alert taxpayers of potential errors in their tax returns.
Another example is HMRC’s Profit Diversion Compliance Facility, which targets a smaller category of taxpayer using data gathered from multiple sources, including business risk review plus and country-by-country reporting. While in many ways this allows for a more targeted approach, it can place an increased burden on already stretched tax teams who need to work to a pre-agreed timetable.
There are downsides to such campaigns. Typically, communications are targeted widely to a number of taxpayers. Given the volume of taxpayers who will be responding to tax authorities on the matter, there may be delays in obtaining responses from the authorities to submissions. These campaigns can also relate to issues arising from historic tax years, sometimes very far in the past. The data required and the personnel involved may no longer be accessible, meaning the enquiry cannot be resolved. Finally, there are limited specifics of why a business has been targeted for the campaign. Therefore, identifying remedial actions (if any are required) can be time intensive.
The second trend is a more sophisticated enforcement approach, where tax authorities have greater oversight of taxpayer assets, and legislative power to more readily enforce liabilities.
We are also seeing tax authorities increasingly requesting access to an organization’s data and using data analytic tools and artificial intelligence to identify errors or areas warranting further investigation. In some countries this includes data one would not normally expect to be directly relevant to tax, for example, regulatory fees.
As an example, the Hungarian tax and customs administration introduced a bespoke tool (known as the Asset Based Tax Debt Collection System) that pulls information from several data warehouses. The system enables segmentation by debt types and debtors, allowing better targeting and identification of assets against which debt can be recovered.
In the UK, since 2016 HMRC has had the power to directly recover debt from individuals’ bank accounts, albeit there are provisions in place to ensure that taxpayers in hardship are unaffected.
One wonders how this trend will continue in future years, and whether other countries will choose to replicate provisions introduced within the UK, such as making HMRC a preferential creditor or allowing HMRC to use surveillance powers to intercept communications and operate surveillance on taxpayers.
We are also seeing the global rise of “naming and shaming,” where businesses and taxpayers who do not pay their liabilities are named publicly. Since 2014, India has published the names of significant debtors on government websites. Similarly in the Republic of Ireland, the Irish tax and customs authority publishes a defaulters’ list quarterly. The practice of naming and shaming tax debtors is common in many US states, where the practice is seen as a way to encourage compliance and achieve policy goals.
The reputational impact of being named and shamed as a non-compliant taxpayer is significant and can be a significant deterrent against non-compliance. However, many authorities are increasing the number of taxes that fall into the regime or decreasing the quantum of liability before a taxpayer will be named. It remains to be seen if the increase in taxpayers caught by naming and shaming will decrease the impact of the deterrent.
On a more positive note, tax authorities are more proactively reminding taxpayers of deadlines, albeit this innovation is primarily used for individuals rather than business taxpayers. Reminders have the dual benefit of ensuring the taxpayer does not suffer penalties and the tax authority is paid in a timely manner.
One of the earliest adopters of this approach was Australia, which sends text messages to taxpayers prompting them of an upcoming liability or overdue debt. A similar approach is taken in Singapore, where the authorities also send text messages before the payment due date for individual property and income taxes. Given that initial analysis shows a higher tax yield and taxpayer compliance, one hopes this trend continues in future.
Taken together, the rise of big data has resulted in more proactive global tax authorities with significant customer data. In response, in-house tax professionals also need to increase their technology sophistication, building data analytics capability to proactively review data sets and submissions. Alongside increasing automation in other areas of tax such as the OECD’s Pillar Two, the next hire in many tax teams could be a tax systems technologist.
Global Green Taxation
2021 saw the Glasgow Climate Pact signed by almost 200 countries. In this, there was a global commitment to limit the rise of global temperature to 1.5 C. Many countries have also signed net zero commitments, where they have committed to be carbon neutral in coming years. Tax is a significant weapon in the armory of governments to implement these commitments.
The first trend is the increased taxation of high emitting industries. Looking at the UK, there are a number of different policy measures designed to achieve this.
First, there is a landfill tax charged to operators of landfill sites. The tax is levied on the disposal of waste to landfill and charged at a rate per tonne disposed. The cost is typically passed onto consumers as higher prices. To encourage reduced greenhouse gas emissions, a reduced rate of taxation may be available, where the materials disposed of are low polluting. The policy intention is designed to divert waste from landfill to other less environmentally intensive methods of waste management.
Second, the government introduced the climate change levy (CCL) and carbon price support (CPS) to encourage businesses to become more energy efficient. The CCL is charged as a fixed amount per kilowatt hour of electricity and gas used. The CCL is collected by energy suppliers, but costs are borne by businesses. Similarly, the CPS is a levy charged by the government where fossil fuels are used as part of electricity generation. The objective of the CPS is to drive investment in low-carbon electricity production by increasing the cost of fossil fuels.
Third, the aggregates levy also encourages the use of recycled materials. It is a tax on the commercial exploitation of sand, gravel and rock, and is charged at a flat rate per tonne of material extracted. The levy was designed, with various exemptions, to encourage the use of less environmentally damaging sources of aggregate.
Fourth, the government allows businesses to obtain enhanced capital allowance deductions where energy saving materials (such as low carbon dioxide emission cars, environmentally efficient plant and machinery) are acquired. This is typically achieved by providing a 100% first-year allowance to businesses that purchase qualifying plant and machinery.
Finally, the UK introduced a “plastics tax” in April 2022, which imposes a liability where plastic packaging (either produced in the UK or imported) does not meet a minimum criterion for recycled plastic content. The aim of the levy is to incentivize the use of recycled materials.
Similar measures have also been introduced in Europe. The most ambitious was the EU Emissions Trading System (ETS). It sets an absolute limit on the total amount of certain greenhouse gases that can be emitted each year by the entities covered by the system. This cap will be reduced over time so that total emissions fall. It also establishes a market for allowances, as regulated entities can buy or receive emissions allowances, which they can trade with one another as needed. Similar schemes have also been implemented in California and China.
Both Spain and Italy have sought to incentivize plastic recycling—this is done by charging businesses that manufacture, purchase or import single use plastics a fixed rate per kilogram. It is expected that this policy will be adopted more widely within the EU, given the “plastics own resource” policy introduced on January 1, 2021.
The impact of increased taxation provides a clear disincentive to use higher polluting products and services, by increasing their cost. However, from a business perspective, moving towards lower emitting production methods can take time, often several years, to complete. Many tax policies are introduced with limited time frames, thereby increasing business costs in the short term if changes cannot be made prior to implementation. It is also worth considering carbon leakage, where taxpayers may choose to relocate production to avoid the extra taxation being imposed. This issue was recognized by the EU when designing the Carbon Border Adjustment Mechanism, but this regime has not been mirrored by other countries.
The second trend is the incentivization of lower emission transport (primarily motor vehicles) and capital items. Globally, one of the most common green incentives is reduced benefit in kind charges for lower polluting company cars. This is a dual incentive for both the employee and company, as the employer’s social security payable by the company is reduced, as well as the income tax and employee social security payable by the employee. Also, where the environmentally friendly company car is purchased by the business, there may also be accelerated capital allowances or tax credits reducing the corporation tax payable.
Linked to this is a greater environmentally conscious employee population. This has manifested itself in the provision of sustainable pension schemes, investments in electric vehicles and recycling infrastructure at offices, and greater emphasis on carbon reduction within the organization.
Overall, incentives and employee sentiment have been a significant contributing factor to encouraging carbon reduction. However, the costs of the transition are high and, while these are partially offset by incentives, there is often still a real cost resulting borne by business. Also, given the disparate incentive regimes, one country offering a generous incentive may not offset other costs associated with that change globally.
An expected increase in tax authority activity, the implementation of new legislation and government policy, as well as increasing digitization, mean 2022 is proving to be another busy year for in-house tax teams.
Tax teams need to be ready to meet these challenges and in an ever more resource constrained world, the automation of tax processes and having robust procedures and policies in place will play an increasingly important role.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Edmund Paul is Employment Taxes Manager and Anton Zuccaro is Group Tax Controller at Colt Technology Services.