Tax avoidance

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See also tax havens and tax policy.

Contents

BP gets $10 billion tax credit for oil spill expenses

There is no shortage of news from BP on Tuesday:

  • The oil major reported its first quarterly loss--$17.15 billion--in eighteen years, and will sell about $30 billion in assets.
  • The company also announced that CEO Tony Hayward will step down on Oct. 1 to work at TNK-BP--BP’s joint venture in Russia.
  • Bob Dudley, an American BP executive, will succeed Hayward as the new Chief Executive
  • The more eyebrow-raising news; however, is that BP plans to claim almost $10 billion in U.S. tax credit as a direct result of the Gulf oil spill. Here is how the tax code and math work.

Under the U.S. corporate tax law, companies can take credits up to 35% of their loss. Since BP reported $32.2 billion charge related to the cost of the spill, 35% of that will give you roughly $10 billion in credit. So BP’s claim is pretty much what its spokesman said.

"This is the accounting process, we are going by U.S. laws.”

The intention of the tax code is to encourage investments and to help companies even out profit and loss, along with the associated taxes. Lawmakers just forgot to incorporate a rider clause for public safety and/or environmental damage related expense.

The tax credit, if claimed, could mean $10 billion of the Gulf aftermath costs would come out of taxpayers’ pocket. This could potentially be quite an embarrassment for the Administration as President Obama vowed that BP will "pay every dime owed" for the spill damage.

Of course, BP could conceivably “do the right thing” and drop its tax credit claim to avoid a crashing tsunami of public anger and outrage. However, don’t expect BP to give up on this sizable cost offset that easily, since BP has made considerable concessions such as a voluntary $20 billion oil spill fund, and speculation of U.S. government’s involvement in Hayward’s dismissal and Dudley's appointment.

As reputation goes, it is hard to imagine the IRS would let this $10 billion slip by. Could revenge of the IRS be in the cards, or as Leona Helmsley famously said “Only the little people pay taxes”?

US firms claim foreign sales to avoid taxes

A U.S. tech company identified only by the pseudonym “Delta” generated as much as 55 percent of its revenue domestically while reporting to shareholders that only 10 percent of its pretax income came from U.S. operations, according to a report presented to the House Ways and Means Committee.

By attributing more earnings to countries with lower tax rates, including the Netherlands and Singapore, “Delta” cut its worldwide average tax rate to less than half the 35 percent rate in the U.S., said the report by the Joint Committee on Taxation, presented yesterday.

Such income shifting, gleaned from actual tax returns in a rare glimpse into the tax structures of six U.S. multinational companies, reflects a strategy that critics call abusive. Companies that use it may be depriving the U.S. treasury of as much as $60 billion a year, according to a study published in December by Kimberly A. Clausing, an economics professor at Reed College in Portland, Oregon.

Multinationals “shift the burden of paying for our national security and homeland security and other public services to small businesses and family taxpayers, who play by the rules and do not engage in these shenanigans,” said U.S. Representative Lloyd Doggett, a Texas Democrat who is on the Ways and Means committee.

That panel, which oversees tax legislation, examined transfer pricing, the system that companies use to allocate their expenses and income among subsidiaries in different countries for tax purposes.

In the report, six companies were assigned false names -- Alpha, Bravo, Charlie, Delta, Echo and Foxtrot. The pamphlet cited percentages for their revenue and pretax income, not real dollar amounts.

Taxman declares war on top end of town

WHEN Kerry Stokes hit the headlines with a proposal to merge his private tractor leasing business with the listed Seven Network, it put a rocket under the media group's share price.

The news of such an odd marriage was enough to distract attention from a ballooning deferred tax liability ticking away on Seven's balance sheet that, when the liability falls due, could decimate a future profit.

Seven's deferred tax liability, which stood at $237 million in June, had swollen to $600 million by February, after a tax amendment bill was introduced into the House of Representatives.

A deferred tax liability is simply an obligation to pay tax at some future time, but it has an immediate impact on the balance sheet. The deferred tax liability has already wiped $1 a share off net tangible assets, which at December 31 stood at $10.18 a share.

Seven's chief financial officer, Peter Lewis, told

BusinessDay the increase in the deferred tax liability was due to the structure in which Seven holds Seven Media Group, its 2006 joint venture with private equity group Kohlberg Kravis Roberts.

The tax bill falls due when the structure surrounding Seven Media Group changes; if the entire business is sold, at least $200 million in the deferred tax liability is triggered.

Welcome to the complex and murky world of tax, which has been the battleground of companies and their tax advisers for years.

It is also where Australian Taxation Office deputy commissioner Jim Killaly is marking out his turf as a maverick, searching out tax avoiders at the big end of town. The expected result is tens of billions of dollars to help ease the growing pressure on the ATO and counter the Federal Government's $58 billion budget deficit.

As seen by the scale of Seven's possible tax bill, big business is the goose that lays the golden egg for the ATO. There are about 1100 economic entities with annual turnover of more than $250 million, which contribute about 36 per cent of total tax collections and 53 per cent of GST collections.

Killaly wants to know why tax collections from big companies have flatlined in the past three years (see graphic on Page 4). And he raises questions about why, between


2005 and 2008, more than 40 per cent of all big business taxpayers that lodged tax returns paid no tax. Of those, 20 per cent were making a profit.

He also questions the inordinate burden placed on the biggest corporate taxpayers. The top 200 companies pay 86.1 per cent of Australia's corporate tax. The remaining 900 big businesses contribute a woeful 13.9 per cent, yet all report turnover in excess of $250 million.

An analysis of the ATO's most recent data shows financial services - far and away the largest tax-paying industry - enjoyed a tax rate of 20 per cent in the five years to 2007. (See graphic.) This is a handy saving for a sector notionally billed at the 30 per cent top company tax rate and one that receives handsome government largesse in the form of a guarantee over its debts.

In a February 17 speech, Killaly pinpointed several industries - finance, energy and natural resources, pharmaceuticals, motor vehicles, and major sales and distribution - for further attention.

Perhaps not surprisingly, the ATO squeezed an extra $700 million in funding from the government in 2008 and another $595 million last year. A good part of this went to Killaly to beef up compliance activity directed at big business.

To this end, Killaly has been on a big recruitment drive, hiring 200 people last year to bring his staff to 1229. In the past few months he has been poaching senior tax experts in the private sector, here and overseas.

The rate of return on investments in big business is shown in ATO annual reports. Killaly's big-business compliance program - tax bills that big business did not want to pay - charged big business $2.1 billion in 2009, $3.3 billion in 2008 and $2.5 billion in 2007. About a third of each of these bills was made up of penalty payments.

The federal government has not been idle either. Its barely noticed Tax Laws Amendment (2010 Measures No. 1) Bill 2010, in part dealing with the arcane art of consolidated accounts, was the source of Seven's increase in its deferred tax liabilities.

According to Howard Adams, a tax partner at Ernst & Young, the ATO is targeting areas of the taxpaying system where it will get most bang for its buck. "That naturally includes the ASX top 200," he said.

And he flags the obvious political imperative behind such a focus.

The GFC and perceived corporate excess have done for tax what Enron did for audits, he says. What was a relatively specialist area of commercial life will be put at front and centre from now on.

During the boom, society didn't think about it so much because we had a budget surplus and ever-increasing revenues. Now we have a deficit that we must redress and tax will act as the recalibrator.

The ATO is party to these imperatives. The additional $700 million was provided to the ATO on the promise of $5.7 billion extra revenue being collected.

But the money was handed over when the federal government was expecting to get $115 billion more in total corporate tax collections in the years to 2012 than its more conservative February 2009 forecast.

So, despite a decline in overall corporate tax revenue, where will the ATO's promise to raise an additional $5.7 billion come from?

Killaly has made it clear it will come from big business. He observed in a speech that big business had enjoyed "reasonably solid underlying economic performance leading up to the global financial crisis, yet tax collections had flatlined from 2007 to 2009.

"The compliance question is whether the tax performance of the large-business sector, and the various markets comprising it, is consistent with its underlying economic performance," he said.

Some bridle at these observations, especially as the ATO's figures show tax collections from large businesses running at a reasonably healthy 24 per cent of taxable income in the five most recent years for which data is available.

The idea that something is completely out of alignment by corporate Australia, I would say strongly is not correct, says PricewaterhouseCoopers tax partner Michael Bersten. He also says the ATO's position is that big business is a consistently large taxpayer, a message at odds with Killaly's inferences about big business.

Dale Boccabella, an associate professor of taxation at the Australian School of Business, says tax collections from big business will be below the company tax rate of 30 per cent because of factors including tax credits (when businesses run at a loss) and offshore income taxed overseas, not in Australia.

But he says the reported tax rate - a measure of tax paid divided by taxable income - does not necessarily represent the full story of tax leakage, with methods of under-reporting taxable income a clear focus of the ATO (see left).

In his speech, Killaly did not say the words tax avoidance, but it was clear that his division will be looking at the 1100 companies with more than $250 million turnover - particularly those making a profit - and finding out why almost half are not paying tax.

The ATO is one of the nation's most powerful regulators. Plaintiffs are guilty until proven innocent and while they try to plead their case, the ATO has a power - and uses it - to impose interest costs and penalties throughout the dispute.

Put simply, the balance is tipped in the ATO's favour.

Just ask explosives and fertiliser group Orica, which this week learnt it may have to pay another $126 million to the ATO after losing a court dispute over a capital gains tax bill arising from the sale of its pharmaceuticals business in 1998.

In the past few months, the ATO has been more active and aggressive than ever in its interpretation of the tax law.

This was nowhere more evident than when it caused a furore late last year when it hit private equity group TPG Capital with a $678 million tax bill after it floated the Myer department store group in November and booked a $1.58 billion profit (see left).

Ernst & Young's Howard believes the game could change dramatically in the next year if the tax regulator in the US, the IRS, adopts a proposal where businesses have to report "uncertain tax positions".

Meanwhile, the war in the shadows continues. A senior tax lawyer refused to be named when he said: There is no question the ATO is targeting big business and the sort of money they will go after will raise tens of billions of dollars.

"There is a nuclear bomb ready to go off and corporate Australia had better be ready."

Australian Taxation office examining tax dodging

THE Australian Taxation Office is examining a series of tax minimisation strategies used by companies to reduce their tax bills, including:

Many related-party loans

KPMG tax partner David Drummond says the ATO has significant concerns about foreign-owned multinationals claiming excessive interest costs and guarantee fees.

In December the ATO issued a little-reported draft ruling that signalled a harder line on foreign companies lending money to their Australian operations.

A loan is regarded as a business expense, and therefore becomes a tax deduction, reducing the overall level of taxable income.

It benefits overseas companies to lend heavily to their Australian subsidiaries at a high interest rate, because it reduces the taxable income and the tax payable in Australia at the 30 per cent tax rate.

Instead, high levels of indebtedness mean the Australian subsidiary pays the overseas parent largely in interest. The parent is charged at a withholding tax rate of 15 per cent.

The ATO's draft ruling aims to ensure Australian companies are not paying uncommercial rates of interest on the loans to their overseas parents, and thereby unduly reducing tax on their Australian operations.

The ruling says relevant provisions aim to tackle international profit shifting arrangements.

These kinds of payments are broadly described as transfer-pricing mechanisms, in which elevated costs charged to the Australian business shift profit to the overseas owner and reduce the Australian business' taxable income.

Clayton Utz partner Niv Tadmore believes transfer pricing will become an increasingly important area for the ATO.

"There are three drivers: the amounts at stake are normally quite large, the legal and factual issues can be uncertain, and there is increasing co-operation among tax authorities around the world," he said.

Housing billing offices in low-tax destinations.

Google has been estimated to be closing in on Australian revenue of more than $1 billion annually through its dominant position in the online advertising market.

Yet the company's Australian subsidiary reported $90 million revenue for 2008, the most recent year available, a $6.2 million loss and a $3.9 million tax bill.

BusinessDay revealed Google's customers were receiving bills from its Irish subsidiary, which enjoys a company tax rate of 12.5 per cent compared with Australia's 30 per cent. In effect, the revenue paid by Australian advertisers finds its way to Google's Ireland billing operations and becomes taxable income there.

Classing revenue as a capital gain.

The guts of the ATO's decision to bill private equity firm TPG $678 million for its sale of Myer rested on a distinction between capital gains and revenue.

The ATO ruled that in selling a company, TPG had been engaged in its ordinary business of buying and selling a company, and therefore should have booked the profit from the sale of Myer as revenue. At the bottom line, this gain would have become taxable.

TPG took the view that the sale was a capital gain, and as a foreign investor it was exempt from capital gains taxes.

The ATO is expected to finalise its position within the next few weeks, but in the meantime private equity, accounting bodies and others are lobbying hard to muzzle the ATO.

Playing shell games with overseas income.

In principle, a company should not have to pay tax overseas on overseas income and then pay tax on it again in Australia.

This tax exemption for overseas income is one of the principle reasons given by tax experts for financial services companies having the equal second-lowest tax rate of industry groupings.

In a speech, ATO deputy commissioner Jim Killaly said some companies might not be properly using tax exemptions for income earned overseas. Income is taxed in another country and a foreign tax credit arises, he said.

But the arrangements allow the Australian company to get a form of set-off from another party in the arrangement for the foreign tax paid so they are not out of pocket.

Nevertheless, the large business seeks to use the foreign tax credit to reduce its Australian tax payable.

Also on the ATO's radar are things like tax consolidation, inter-group financing, equity-raising issues, loss profiling, debt-equity divide, thin capitalisation, debt levels, valuation methodologies and non-resident withholding tax.

References

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