Covid-19 offers governments an opportunity to overcome the barriers that tend to block ambitious tax reforms and changes to the way that taxpayers and tax administrations interact. Nowhere is this more evident than in the way we tax multinational enterprises (MNEs), which in most countries, especially developing countries, account for the bulk of corporate tax revenues.
In parallel with the ambitious reforms of the international tax arrangements currently being undertaken by the Organization for Economic Co-operation and Development (OECD)—and it remains an open question whether Covid-19 will accelerate or slow down this effort—we also need to ask if can we use the crisis to have a “quiet revolution” in the way that large MNEs and tax administrations interact, moving away from a confrontational approach to one that is open, transparent and constructive.
This is what cooperative compliance programs are all about and yet despite the efforts of the OECD’s Forum on Tax Administration, too few countries use this concept and even those that have pioneered it (e.g. the Netherlands) appear to be having second thoughts. This article draws upon a multi-stakeholder project at the WU Global Tax Policy Center, which will produce a handbook that tax administrations and business can use to implement cooperative compliance programs.
Government expenditures are unlikely to fall back to pre-crisis levels for some time, so governments are going to need to increase tax revenues. They need to do so in a way that does not worsen the business tax environment and discourage foreign direct investment (FDI). Cooperative compliance programs can help to reconcile these two objectives by providing greater certainty about the flow of corporate tax revenues and greater certainty for MNEs over their tax liabilities.
Cooperative compliance programs can play an important part in an overall risk-driven compliance strategy, designed to maximize the use of limited resources and minimize tax uncertainty. They can also help tax administrations to get a better understanding of the global operations of MNEs, and thereby helping them to ask the right questions, provide more certainty to taxpayers and improve the climate for FDI.
Cooperative Compliance Program
Cooperative compliance programs first got onto the international agenda after the 2007–08 financial crisis when tax administrations wanted to protect the revenue base from aggressive tax planning but recognized that in a difficult economic environment an over-aggressive approach would be counterproductive.
Today’s crisis is far worse, and rebuilding the public finances will be a challenge. In this environment governments need to be wary of introducing tax measures that increase tax uncertainty. Business will want to show to the public that they are playing a constructive role in the recovery and may welcome cooperative compliance programs as one way of doing that. Also, these programs can be seen as a part of the general trend towards greater tax transparency, with a growing number of MNEs publishing more information about the taxes they pay.
Cooperative compliance programs are tax compliance programs primarily designed for large business taxpayers. They represent a shift from retrospective control based on a comprehensive tax audit to a cooperative relationship between tax administration and taxpayers based upon the discussion of the tax issues in real time or even prospectively.
The program can be defined by description of the capabilities required of tax administrations wishing to put in place a cooperative compliance program and the implications for taxpayers wishing to enter into a cooperative relationship with those tax administrations.
Obligations on Tax Administration
Within the framework of a cooperative compliance program the tax administration is expected to offer:
- Commercial awareness
The tax administration should have a good understanding of the commercial drivers that are behind transactions and activities undertaken by taxpayers. The tax administration needs to understand the broader context of an activity or transaction and respond in a way that minimizes avoidable and potentially costly disputes and uncertainty.
The tax administration is required to approach the task of issue resolution with a high level of consistency and objectivity. It should maintain a professional and critical attitude towards the large businesses it deals with and the information it obtains in the course of its dealings with that business.
The tax administration should make proportional choices in allocating resources and deciding which taxpayers, or which tax issues, to prioritize.
- Openness and transparency
The tax administration should be open and transparent. The scope of openness and transparency offered by the tax administration depends on the specific legal and constitutional principles in operation.
Certainty in taxation implies timeliness: the tax administration should agree some timelines with large business taxpayers within which the tax administration will respond to the taxpayer.
There needs to be an effective system of internal governance. Its aim is to ensure that the officials dealing with tax affairs will adhere to the principles that underpin the cooperative compliance program. It also provides external stakeholders (ministers and the wider taxpaying public) assurance that the cooperative compliance program is a mechanism for delivering improved tax compliance and not some form of illicit advantage for the very largest taxpayers.
The cooperative compliance program imposes certain obligations on the large business taxpayer participating in it. The taxpayer should provide the tax administration with all the information that it needs to make fully informed risk assessment of the tax issues arising from a tax return, including any specific transactions or positions that raise questions that are particularly uncertain, difficult, or controversial from the standpoint of the tax administration.
Tax Control Framework
An essential feature of the cooperative compliance model is the tax control framework (TCF) within an MNE, which is understood as the part of the system of internal control that assures the accuracy and completeness of the tax returns and disclosures made by an enterprise. It gives legitimacy to the program by providing a clear and objective basis on which the tax administration can base its decision to trust the statements made by the taxpayer.
A taxpayer’s tax control framework must include the following features.
- Tax strategy
This should set out the strategic objectives of the business, the role of the tax department, and its approach to ensuring compliance with the law. It needs to address all aspects of the business at all levels, from the strategic to the operational. In particular, it will set out the business’s attitude to and appetite for tax risk. The strategy should be owned at Board level.
The tax control framework should cover all policies, procedures and processes that can affect the correct assessment and reporting of tax liabilities.
The tax control framework should be developed by senior management and approved by the CFO or the Board. It should provide that any tax strategy is executed by people with the right skills and experience.
The tax control framework should describe the mechanisms, processes and relations by which tax issues are controlled and directed. The prime responsibility for ensuring the system works should lie in hands of the Board.
This feature of the tax control framework refers to its maintenance and monitoring. The system should contain feedback tools which aim at preventing, detecting and correcting errors. Regular testing of the tax control framework should make it possible to assess whether the system is adequate. The tax control framework needs to be dynamic, so that it responds to changes in the underlying business and issues that have arisen from the regular testing of the integrity of the control regime.
This is provided when all the other features of the framework are fully implemented. That is what provides assurance to all stakeholders, including the tax administration, that the taxpayer has an effective system which enables it to control all tax risks and issue reliable tax outputs.
A tax control framework that has all these features delivers the justified trust that is central to the cooperative compliance model. It enables the tax administration to focus on assuring the integrity of the control processes in MNEs, rather than trying to routinely undertake its own verification of the way in which individual transactions have been recorded in taxpayers’ accounting systems.
Drivers for Implementation of the Cooperative Compliance Programs
Implementation of a cooperative compliance program has the potential to deliver many benefits to different stakeholders, ranging from tax administrations to policy makers to investors, especially in the post Covid-19 environment.
From the perspective of the tax administration, cooperative compliance programs can contribute to improving voluntary tax compliance. A cooperative compliance program works as a procedural “tax incentive.” It facilitates compliance by providing timely advice on tax issues and thereby affects the behavior of a broad group of taxpayers: those willing to be compliant, those who operate in high-risk sectors, and others for whom tax certainty is a tangible benefit of the program.
As a result of improved tax compliance, in the longer-term the revenues paid voluntarily will increase. In the near term, settlement of legacy disputes, which is a first step in establishing the new relationship, could deliver significant one-off yield.
Given that a cooperative compliance program relies on an intense interaction with transparent large corporate taxpayers, the tax administration improves its commercial awareness and develops better understanding of how MNEs manage their business and the control systems they rely on to ensure that their accounts and returns are accurate. This knowledge will improve the capability to identify and address compliance risks in other cases. It also enhances compliance risk management, and should result in better targeted and more productive audits.
Finally, thanks to transparency and full disclosure, the tax administration will obtain a full understanding of the specific issues and risks that affect taxpayers participating in the program. As a result, the tax administration can focus on the correct resolution of those issues and keep the cost of its compliance activity in these cases down and free up resources to focus on higher risk taxpayers.
But the cooperative compliance program provides benefits to the taxpayer too. First and foremost, it offers taxpayers earlier certainty about their tax liabilities, and that is commercially valuable. Cooperative compliance operates based on on-going discussions between tax administrations and taxpayers. Discussing tax issues with the tax administration on a regular basis can reduce the need to make provisions for uncertain tax positions and unexpected tax liabilities. This should lead to improved tax compliance and greater certainty. It should also lower compliance costs.
As a result of cooperation with the tax administration, the taxpayer is less exposed to administrative penalties, and can file and settle tax returns quicker. Tax audits are more focused and quicker. The number of disputes, if any, that involve extra costs should be lower. Tax issues are better integrated in the taxpayer’s internal processes and underpinned by a tax control framework that enables better and easier tax risk management.
Participation in a cooperative compliance program promotes trust, mutual understanding and transparency. From a taxpayer’s perspective, reputational gains may also be an important driver. Given the largely hostile tone of political discourse about the role of MNEs in the current economic environment and our exit from the Covid-19 crisis, taxpayers participating in the cooperative compliance program may be seen as a more reliable partners and as good corporate citizens. Shareholders will have greater confidence in the returns from investments if the tax position of the MNE is more certain. This eventually leads to a better investment climate which could give a country a competitive advantage and help in the recovery from the Covid-19 crisis induced lockdown that most economies are suffering from.
Cooperative compliance may contribute to designing better tax policy through more open dialogue between government and business. Cooperative compliance is about building trust, mutual understanding, openness and transparency into the relationship between the tax administration and taxpayers. These are the pillars of good governance. Cooperative compliance creates a climate in which it is easier to involve taxpayers in discussions about the laws that affect them and their application. It may improve legitimacy of taxation through a better understanding of tax policy decisions by taxpayers.
This article has provided a brief introduction to cooperative compliance programs and has shown why this approach can help both governments and large business manage more efficiently the operation of the corporate income tax. These programs are part of a wider move towards greater tax transparency with MNEs facing pressure to publish information of where they pay taxes, as recommended by Global Reporting Initiative of the Global Sustainability Standards Board (GRI 207). In a post Covid-19 period characterized by global economic and political uncertainty, these programs can help minimize tax uncertainty.
Let’s use this crisis to fundamentally change the way that tax administrations and MNEs interact.
Professor Jeffrey Owens is Director of the WU Global Tax Policy Center at the Institute for Austrian and International Tax Law, WU (Vienna University of Economics and Business).
The author may be contacted at: firstname.lastname@example.org
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.