Recently, companies have increasingly been making headlines as a result of dubious tax practices. The revelations about the Panama and Paradise Papers by the Süddeutsche Zeitung, the cum-ex practice, and structures for tax avoidance in Europe, in particular among U.S. tech companies, were frequently discussed in business news in Europe.
Status Quo and Cost Advantage of Lower Taxes
Whilst the persons named in the Panama Papers and the companies involved often acted illegally, and the courts are still deciding whether the cum-ex deals are right or wrong, cross-border corporate law structures established to exploit different advantageous tax regimes are actually legitimate and frequently used in practice.
It’s not just the U.S. tech groups that are using these structures. Other well-established European companies, which are considered to be sound, “shift” their profit to countries in the EU and other jurisdictions where taxation is low. Even companies in which the state holds an interest are involved.
In highly competitive fields, such as the German maritime industry, this practice is actually understandable. Taxes are costs which either reduce the margin, or sometimes even make an offer so expensive that it is no longer competitive. Keeping costs as low as possible by keeping taxes low is also more attractive for shareholders.
There is a real disadvantage if competitors are located in territories where taxation is low; and companies from territories where taxation is high, such as Germany, France, Italy or the U.S., will try to compensate for this disadvantage. This is purely an economic approach based on current legislation, and it is legal.
Tax Ethical Conduct as a Sales Argument
Press reports have depicted many companies in a negative light to the general population, even though the companies’ conduct was in conformity with the law: their approach to taxes, however, contradicted their corporate social responsibility.
Consumers who can afford to use more expensive products and services are frequently willing to avoid certain companies because their reputation is questionable. These consumers will no longer purchase from companies that do not meet their moral expectations. Ethical conduct can therefore also be a sales argument for companies whose purchasers are consumers.
On the other hand, for commercial purchasers, quality and price are usually the decisive factors, unless companies can use the ethical advantage with their own customers, and benefit from it.
Since private consumers increasingly base their buying behavior on ethical sales arguments, the demand for fair trade products (for example, chocolate, coffee and bananas) has increased significantly in recent years, in comparison to traditional products. The proportion of products with (allegedly) eco-friendly features, such as electric cars, or eco-friendly manufacturing, such as green electricity, is also growing. Some companies, such as beer producers or internet search engines, promise to a plant a tree for each case of beer purchased or for a certain number of search requests. This approach has been quite successful.
A key factor then, in the purely economic assessment of the issue of whether to refrain from international tax avoidance structures as a company, will be whether this argument can be used to convince buyers to purchase the product or view the company in a positive light.
However, the argument for behaving in an ethical tax manner does not appear to be as effective as environmental conservation and social corporate responsibility. Approaches that focus on eco-friendly aspects or societal concerns are generally much more effective in the eye of the public.
The following considerations make this quite clear.
An Effective and Powerful Marketing Instrument
Paying taxes is less visible than planting trees or protecting poor people from labor exploitation. The “good deed” is far more complex with respect to taxes. Most people do not have sufficient knowledge of tax law and fail to understand what some companies do (or fail to do); as a consequence, the majority of people have a very abstract idea of what “ethical tax conduct” is.
If a company states that it pays taxes in Germany for instance, the general public cannot really verify this. It is simply not possible due to fiscal secrecy, and the sheer extent of the accounting documents. It would not be possible for individual consumers to check these documents, even if the company were to publish them and possibly reveal business secrets regarding sales and procurement markets. On the other hand, it is much easier to check whether trees have been planted.
One possibility would be to have a chartered accountant confirm that a company has refrained from tax avoidance activities. However, it should be borne in mind that in many cases the auditing companies have provided advice to improve the respective company’s tax burden.
Risks of Advertising Tax Ethical Behavior
A company that advertises by stating that it pays a lot of tax and does not use tricks to reduce or avoid taxes can face a public relations disaster. For example, transfer pricing in particular entails considerable potential for dispute. An approach which may be well accepted in one country because prices on intra-group transactions are advantageous for it by nature, may harm another country because the same transfer price is disadvantageous for the latter. There is hardly a safe approach in this respect. It will be possible at any time to find fault with the company for any price. A company can only avoid this catch-22 scenario by paying tax in two countries, i.e. accept double taxation. However, this cannot be the goal, either economically or morally.
Other Advantages of Ethical Behavior
Other stakeholders in the company who are not investors or consumers are easier to reach with tax ethical behavior—specialists or skilled workers. An employee or job applicant generally knows much more about the company than a consumer who is flooded with information. Employees and applicants are better able to understand the company’s efforts in this area as they have more time and interest to do so.
Particularly now, as the market for skilled workers is becoming more competitive, this can be a decisive point when job applicants decide whether or not to accept an offer. It also facilitates staff retention and loyalty. Who wants to admit that they work for an unethical company?
Others can profit from ethical tax behavior as well.
The press likes to report on the wrongdoing of companies but also on corporate decisions that are made responsibly and ethically. Just like other ethically sound decisions by corporations, the public welcomes ethical tax behavior. If public relations becomes involved, it is possible to attract public attention. The company can be in the news regularly. If it is presented, for example, in the form of an information event for invited guests, tax-ethical behavior could also be leveraged for networking purposes at such events in order to reach specific stakeholders and not just the general public.
Disadvantages of Tax Avoidance Structures
It is important also to bear in mind that using tax avoidance structures may entail disadvantages and may be risky.
In particular, tax authorities in the individual countries concerned, which are also stakeholders in the company, cannot be overlooked. They usually have instruments at their disposal which can hit commercial enterprises hard. Since the relationship with tax authorities spans the entire duration of the enterprise, it can be very difficult if problems arise.
As a rule, tax authorities do not condone tax avoidance. High transaction costs and administrative costs can result for companies if authorities feel there may be potential for a dispute in an international tax matter and seek disclosure in this respect. The consequence can be long tax audits, detailed and resource-intensive requests and demands for documents, time-consuming lawsuits and a detailed review of minute issues by the tax officials who have been informed.
In addition to the transaction costs, (aggressive) tax avoidance activities also frequently entail the legal risk of losing a lawsuit against tax authorities and not achieving the desired result with the structure chosen. Moreover, in practice there has been an increase in the number of criminal tax proceedings. On the one hand, legislation or case law forces tax officials to transfer the file to public prosecutors’ offices where significant tax penalties are at stake, and on the other hand, the tax authorities try to apply pressure on taxpayers and improve tax morale.
These risks can be significant, both financially and to the company’s reputation, and they restrict the planning security desired in the company, in particular in the area of finance and liquidity.
In the end, decisions on ethical tax behavior must be considered from a purely economic view in each individual case.
For companies that uphold and exercise social responsibility anyway, ethical tax behavior is a must. It completes the picture of the company based on the general good, and therefore serves as an effective marketing tool. Anything else would damage its carefully developed image.
Companies that would like to address sensitive target groups should also seriously consider ethical tax behavior as a sales argument. It is important that tax topics are handled very sensitively, and, in the event of any doubt, the tax authorities are closely consulted for professional assistance.
As a part of branding, not as an advertising tool in itself—since tax ethics are not as visible as planting trees—tax ethical behavior can definitely contribute to an economic and sustainable business strategy, strong stakeholder relationships and to gaining and retaining employees.
The quantifiable advantages such as a lower risk of litigation, costs and interest, as well as lower transaction costs and planning security, should not be underestimated either.
Björn Demuth is a Partner with CMS Hasche Sigle