Mitigating risks that will emerge from OECD's global tax plan

SINGAPORE - Unprecedented worldwide stimulus support in 2020 has dramatically inflated public debt and governments are now determining how to pay this down by adjusting their tax collection regimes.

An Aon study this year noted that among tax-related anxieties, the greatest concerns identified include increased rates (34 per cent) and a proliferation of anti-abuse rules(26 per cent).

The latter is consistent with the Organisation for Economic Co-operation and Development's (OECD) agreement to coordinate government efforts in tackling base erosion and profit shifting.

Under the OECD's Two-Pillar Plan, Pillar One is focused on profit allocation and nexus; Pillar Two on introducing a global minimum corporate tax rate of 15 per cent to multinationals with a consolidated revenue of above €750 million (S$1.2 billion). Essentially, Pillar One seeks to expand the taxing rights of certain multinationals to market jurisdictions and Pillar Two has the effect of setting a floor on competition among countries over corporate income tax.

With 133 countries now having joined the Two-Pillar Plan, companies will undoubtedly have to start reviewing their existing global structures to assess if they are fit for purpose in the new tax environment.

It may still be too early to comment on the exact impact with the detailed implementation plan set to be announced next month. However, Asian firms would need to manage the risks that arise in a world with minimum corporate tax rates. This is especially crucial if companies plan to undergo a restructuring exercise once the design elements are firmed up.

Tax risks could arise from many issues - from domestic tax risks on positions adopted in the past, to restructuring, tax treaty risks and transfer pricing, among others. In addition, in an evolving economy where knowledge and innovation are differentiators in the market, the value of Intellectual Property (IP) will continue to grow and companies will be looking at it as a key asset in their plans. Enterprises that own IP across Asia need to be mindful of tax risks in any restructuring exercise.

Companies looking to acquire or divest would also need to manage the exit taxes and valuation issues if IP is migrated to another jurisdiction. A careful analysis of the business operations and specific tax risks arising from the reorganisation must be done as it can often take years before specific issues come to light in the form of an audit.

Across Asia, the global effort to introduce a minimum tax would reduce pressure on governments to provide for tax exemptions or lower corporate tax rates to stay competitive, and instead shift the focus to other areas such as infrastructure, workforce, connectivity, rule of law and governance to differentiate itself from the others.

Under the principal purpose test, it will be vital to show the business purposes behind an arrangement or transaction in relation to which the treaty benefits are applied. Across Asia, several authorities have issued guidance as to how the rules would apply but, given the inherently subjective nature of application, this may result in uncertainty for businesses. So, it is critical to re-assess current business structures. Taxpayers with commercial justification for their transactions should not be too concerned with the principal purpose test but should prepare files to support their application of treaty benefits.

Implementing an effective tax risk management framework is thus vital and can help businesses in their decision making. It would also aid them in pre-empting tax inquiries and disputes and show authorities that companies are in control of their tax processes.

Technology should be a fundamental tool in any firm's risk management as financial data is paramount in tax planning. Data analytics can be used to provide deeper analysis of tax processes and risk profiles and help manage an audit defence by providing timely reports, resulting in increased tax efficiencies.

In fact, tax audits are now driven by analytics. Companies stand to gain by investing in tax technology, which would help lead strategic initiatives and highlight risks upfront. A tax risk management framework which aligns people, process, policies, data and technology would help an organisation mitigate risk and add value.

Even if the structure of prior arrangements were commercially driven at the time, firms now worried about tax uncertainties may seek innovative solutions such as a tax liability insurance policy to reduce or eliminate the exposure arising from a challenge by a tax authority by transferring the risk to an insurance provider.

According to Aon's study, 80 per cent of respondents ranked tax risk as a more serious threat to deal success now than in the recent past, including 46 per cent who say the risk is now more acute. Through the deal process, professional advice and diligence are critical to understanding uncertain tax positions in the acquired company and any tax risk that exists.

With many expecting more tax enforcement as governments address their increased public debt due to stimulus measures, firms should mitigate these risks upfront to deliver value to stakeholders. In the context of tax risks in transactions, apportioning risks between buyer and seller can be a lengthy process. Both need to make good faith judgements as to how the rules may apply.

As application of the law in this area may be uncertain, parties can remove these obstacles by using a tax liability insurance solution that can do away with the need for escrow and ultimately increase value and certainty to businesses. These tax concerns coupled with generally existing tax uncertainty are inherent in a merger or acquisition when an acquirer steps into the target firm's tax exposures and open tax years. Unlike other risks that may be more visible, tax risks can be harder to predict here.

A forward-looking perspective in mitigating risks through systematic risk assessment and risk management approach is vital.