Although the end of the credit crunch may be at hand following various government bail-outs, the potential tax crisis following the meltdown of the world’s banking industry is yet to come.
Today’s troubled banks and corporations will look to offset their huge losses against their future income and will hope to benefit from these tax deductions, according to Gianmarco Monsellato, Managing Partner of leading French tax law firm Taj, a member of Deloitte Touche Tohmatsu in Neuilly-sur-Seine.
But various tax authorities may refuse to allow these losses to be offset by income that’s generated in their countries. French tax authorities, for example, may refuse to allow CDO trading losses to be offset against French income when the losses were caused by the US market meltdown.
“Many banks are showing substantial losses,” says Mr Monsellato. “The big question now will be whether they can book their assets against their losses or whether their tax policies will expose them to rejection of those losses from the Tax Authorities.”
Tax authorities may dispute that the tax losses shouldn’t be booked in their countries as they were caused, say, in the US and should therefore be offset against income generated in the same nation.
“This is going to be a very big issue in the coming years because you will see many tax authorities argue that the losses have not originated in their jurisdictions and should have been booked elsewhere. It will be a big transfer pricing issue,” Mr Monsellato warns.
The burden of proving where the losses took place will be on each individual company and not on the tax authority, which can easily refuse it.
“It’s very likely that many companies will wake up one day and there will be taxes to pay in a country where they thought they had a loss. This will be in two to three years from now,” says Mr Monsellato. “When the credit crisis is over and companies are recovering, they will have to manage another wave of crisis which will be a tax crisis. Japan, Europe and the US will fight like hell to push back the losses into the other’s jurisdiction.”
This threat of a tax crisis caused by today’s current credit crunch highlights the importance of good tax management, according to Mr Monsellato.
Effective tax rate
A future tax threat, in particular, highlights the importance of managing a company’s “effective tax rate” which is the true indicator of the tax burden, according to Mr Monsellato.
A company’s effective tax rate is defined as the actual income tax paid divided by the net taxable income before taxes and is expressed as a percentage.
The effective tax rate, which can exceed 50 percent in some companies varies depending a variety of factors, and the nominal tax rates shown by the countries are not always a fair indication of their effective tax rate. Germany, for example, decreased its corporate tax rate to as low as 25 percent in 2008, but at the same time has seriously restricted the carry forward its tax losses. This stopped taxpayers from using those tax losses to offset any tax to be paid in income in a future year, thus increasing the effective tax rate of Germany companies, said Mr Monsellato. Reports say the effective tax rate in Germany is as high as 39 percent.
France, on the other hand, has a high corporate tax rate of 34 percent, but a French company’s effective tax rate is closer to 25 percent because of the many deductions the French tax authority offers, says Mr Monsellato.
“The effective tax rate did not create the credit crisis, but the current environment dramatically shows the importance of managing the effective tax rate,” said Mr Monsellato. “Why? Because, looking at the big picture, the free cash flows of a company are impacted by three factors: the productivity of the corporation and right now that’s going to be an issue; the financial results and right now that’s a big issue; and the effective tax rate.
“In a crisis environment, companies tend to be much more careful and much more focussed in how they manage the tax rate.”
Good communication
Excellent internal and external communication about tax policies will also benefit companies should a tax crisis erupt, says Mr Monsellato. However, substantial progress needs to be made on this account.
“Good tax governance would allow a CEO or CFO to explain to the board whether there will be tax issues derived from the (credit crunch) losses or whether it’s well managed and whether when the crisis is over, it’s over on all fronts,” says Mr Monsellato. “But right now, I’m sure that many boards don’t have a clue about that issue. I’m afraid it may only come up on their agenda in three years when there’s the first tax controversy.
“The majority of boards are not managing tax right now. That’s a fact, because they consider it to be a pure technical issue. The majority of companies do not have a board that truly understands the tax policy of its company.”
But tax is not only a financial issue; tax is also a communications issue, Mr. Monsellato emphasises.
This has been true for the past few years, certainly since GlaxoSmithKline, the UK-based pharmaceutical group, had a public dispute with the US Internal Revenue Service that could have amounted to $15bn in taxes and interest, reports say. In 2006, however, GlaxoSmithKline agreed to pay $3.1bn to settle the ground-breaking transfer pricing tax dispute with the IRS over the company’s profits and charges for the gastro-intestinal drug Zantac.
This case was one of the first times that so much publicity was given to a transfer pricing tax controversy.
“Countries tend to use tax as customs barriers,” says Mr Monsellato, particularly in Japan, the US and now Europe.
“If you are a foreign company doing business in, say, Japan and you end up with a tax controversy with the Japanese authorities, then in Japan there is no secrecy about these tax disputes,” says Mr Monsellato. “The Japanese press, often based on communications issued by the Tax Authority will be described in the press as the foreign taxpayer refusing to pay the local tax.”
Such publicity could hurt the company’s standing and brand image in Japan.
The US tax authorities also are very familiar with communicating in the press about tax controversies of non-US companies, describing them as not paying their fair share of tax which could hurt their position in the US market. The Italian authorities, too, named many US companies in a national newspaper for failing to pay their tax in Italy and that’s not good for their position in the market.
“So when I meet my clients at board level or CEO level now, they are getting very concerned about the image or brand-name exposure they have as a result of their tax policy or their unknown tax exposure,” says Mr Monsellato.
It is important to make sure that your company’s effective tax rate is safe and secure, and that the board of directors knows what their company’s tax exposure is.
“You must find equilibrium between efficiency and certainty and avoid any tarnishing of your brand name,” says Mr Monsellato. “This issue will be more and more important because we’re entering a world where individual customers are going to be very anxious about their future, and they certainly will not buy products from a company that rightly or not is considered an aggressive taxpayer.”
Board must know
In order to improve internal tax governance, tax officials should report directly to the board and tax policy should be the subject of board review, says Mr Monsellato.
“Right now, at least in continental Europe, too few companies have tax officials report to the board. Most of the time, they report to the chief financial officer and it stays there,” says Mr Monsellato. “That’s not appropriate. The board should be aware of the tax policy. The board should be aware of the tax exposure and should make sure that the management is taking the right steps…”
“Right now, there is a significant amount of work to be done to raise the attention of the boards of international companies about their tax policies,” says Mr Monsellato.
Because tax is so technical, many non-tax executives stay away from it and that’s the biggest mistake the board can make. “Because, at the end of the day, it’s not a technical issue, but very much a financial, comprehensive issue,” he says.
“The board must take control of their tax issues; and the tax people must start to learn to speak simple English or French” so that the board and the public can understand the company’s tax policy, says Mr Monsellato.
The biggest issue and the biggest priority for the next 10 years will be to communicate to the board, to tax authorities and to the public in simplistic terms the tax policies of the company.
“Right now, we see absurd articles in the press about tax which are wrong and inaccurate,” says Mr Monsellato. “We see poor communication from the political people about tax which is wrong and inaccurate.
All those inaccuracies and absurdity is hurting the corporate image. Now it’s up to the tax people within the companies to start communicating about what they do and what they don’t do very clearly so that they are understood. It’s up to them to write their own communication about tax to make sure that clients understand it and the board understands it. It is the only way for a CEO or CFO to be on top of its tax policy…. communication is going to be very important for tax people in the future.”
For further information tel: +33 155 616 346; email: gmonsellato@taj.fr; www.taj.fr
