Changing tax

Many tax professionals in the financial sector may have been so shocked by everything that has happened over the last two years, that it is perhaps hard to stand back and take stock. But if some of the key trends, which should be familiar to readers, are followed through to their logical conclusions, then the tax world could start to look fundamentally different. Hugh von Bergen, Tom Aston and Victor Mendoza look ahead.

Tax directors and fellow professionals may have to adapt to a rather different world after the financial crisis. There are four particular areas where some organizations should consider new ways of thinking to manage the tax rate effectively.

1. Corporate tax rates
The last few years have seen a reasonably consistent downward trend in tax rates. In Europe, the race to the bottom has been led in particular by Ireland and some of the Eastern European states who joined the European Union in 2004. But with public sector balance sheets in these countries under extreme strain, it is not unreasonable to suppose that their appetite for further corporate tax reductions in the short-to-medium term may be rather limited. Indeed, they are probably faced with a difficult decision on whether they can sustain their current low rates.

Even if headline corporate tax rates do not increase, it may be fair to assume that effective rates will, with (for instance) tougher rules on interest deductibility in Germany and the UK possibly being an indication of things to come. As many governments start to acknowledge massive deficits in pension and healthcare provision, this upward pressure on the corporate share of the overall tax burden is likely to remain acute.

However, if you are the CFO of a bank with a large deferred tax asset from losses that you expect to use over a number of years, and that asset is supporting your balance sheet and forms part of your Tier 1 capital, then higher tax rates can be advantageous, in that they increase the effective value of past losses. One of the real challenges over the next few years will be preserving and utilizing the tax losses that have been racked up during 2008.

2. Much lower interest rates
For many groups in the financial sector, operating in multiple jurisdictions and a need for funding have meant plenty of opportunities for tax planning. For example, by structuring borrowings with funding costs deductible for the borrower in country A, but not taxable for the lender in country B. The value of such tax arbitrage falls as interest rates fall: many cross-border financing arrangements will provide much less benefit in terms of reducing a group's effective tax rate in the longer term.

However, interest rates on intragroup borrowing are typically linked to London Interbank Offered Rates (LIBOR) and set in advance. At the same time, the widening of credit spreads over the last 12 months has shown that LIBOR may not be a reliable measure of the real cost of borrowing. A more careful analysis should, in many cases, show a significant premium over headline interest rates. In future, tax directors should find significant potential for benefit in a more careful analysis of actual borrowing costs, and in paying continuing attention to appropriate rates as cross-border differentials change.

3. Real-time working
It was not so long ago that having 10 or even 20 years' worth of open tax assessments was common in some countries. While this might still be the case for a few groups with very difficult transfer pricing issues, in many cases the position is now likely now to be much more up-to-date.

In many ways this is a desirable trend. However, it could potentially result in limiting freedom of manoeuvre. Traditionally, when assessments remained outstanding for a number of years, it was possible to negotiate a package deal with the authorities to close a batch of assessments. This would most likely reflect an effective discount on the total liability in return for a dispute-free agreement. With more and more assessments being settled up-to-date, the opportunity for such deals narrows. Moreover, the increasing sophistication of tax authorities in determining the treatment of particular measures in advance of actual implementation, means that the tax director's flexibility to exercise judgment in setting the tax provision is further circumscribed.

In many cases, the only issue remaining on the table will be transfer pricing, but this is perhaps one of the most intractable and the one with the greatest scope for judgment.

4. Greater simplicity
Across the financial sector, KPMG member firms are seeing an almost universal pressure for a move to a simpler legal entity model. Historically, complexity has fit well with what tax directors have wanted to achieve. Quite apart from the fact that complex structures are often a necessary reflection of complex commercial and tax realities, it has also made sense to have complex structures to facilitate financing, foreign tax credit and Controlled Foreign Corporation (CFC) planning.

Legal entity rationalization programs threaten to sweep away legacy entities with significant tax attributes (notably losses). They may also put pressure on the tax function to justify the continued existence of various special purpose vehicles.

How can tax professionals respond to this development? First of all, they should take a new, informed look at which entities are important, and those which are nice to have but could perhaps be sacrificed in the pursuit of wider group objectives. However, some planning (such as that aimed at maximizing the benefit of foreign tax credits) may be less relevant in a tax loss environment. Once again, tax directors face the challenge of balancing competing pressures.

Towards a more strategic role
One theme underlies all of these areas: the need for tax directors to take a more long-term and strategic approach to determining tax policy. At the same time, governments are going to be increasingly desperate for receipts, and increasingly aggressive in attempting to block tax planning.

Governments face a series of policy dilemmas. Some may be tempted to raise tax rates to increase revenues in the short-to-medium term. Others may push rates down to attract more inward investment. Some degree of international tax competition will continue. Ultimately, governments should recognize the need for collaboration and convergence. A more level playing field should result in a simpler, more stable system - and the greater certainty this provides to companies will have clear benefits. The role of the tax director will be to help position the company correctly as this new landscape develops.

Article authors

Hugh von Bergen
Global Head of Tax
Financial Services
KPMG in the UK +44 20 7311 5570 Hugh von Bergen View all articles by this author

Tom Aston
Partner
KPMG in the UK +44 20 7311 5811 Tom Aston View all articles by this author

Victor Mendoza
Partner
KPMG in Spain + 34 914 563 488 Victor Mendoza View all articles by this author