International Tax Transparency
Arthur Cockfield, Queen's University Faculty of Law
"Sunlight is said to be the best of disinfectants."
—Louis D. Brandeis in "What Publicity Can Do," Harper's Weekly,
December 20, 1913, 10-13, at 10.
Introduction
An imbalance exists between tax authorities and taxpayers when it comes
to the latter's financial information. Taxpayers have the information
they need to calculate their tax liabilities and file their returns. Tax
authorities, on the other hand, tend to have little beyond what is in
the tax return. Thus it can be hard for tax authorities to detect
non-compliance. The solution? Pass laws to force the taxpayer (or a
third party) to provide more and better information to tax authorities.
In other words, increase tax transparency.
Concerns related to tax transparency are numerous and important. Some of
the articles elsewhere in this issue offer various perspectives on the
balance between disclosure and privacy in the context of tax audits.
Other articles discuss recent domestic legislative initiatives that
reinforce the international trend toward the enhanced disclosure of
income from various sources and of beneficial ownership of property.
Another contribution to this issue, by a European tax professional,
describes the "DAC 6" disclosure regime, introduced by the European
Commission in 2018. In this article, I focus on the broad international
trends that have been the principal catalyst for measures to address
domestic and international tax transparency.
Multinationals and Malefactors in the Offshore World
Today's efforts to make the global financial system more transparent
arose from political reactions to a number of events. One of these
events was the 2008 global financial crisis, which brought financial
distress to many governments. These governments began to take a closer
look at revenue losses from two sources: (1) tax non-compliance and
(2) international tax planning that exploits the differences between the
tax laws of various countries. In 2013, the Organisation for Economic
Co-operation and Development (OECD) and the Group of Twenty (G 20)
countries began the base erosion and profit shifting (BEPS) project, an
ambitious reform that aimed, in part, to address these revenue losses.
One outcome of the BEPS project was the country-by-country reporting
(CbCR) system, which forces large multinational firms to disclose tax
and other payments they have made in every country where they operate.
A second catalyzing event was a series of
data leaks from tax havens.
These leaks brought the world's attention to governments' revenue
losses from offshore tax avoidance and tax evasion. Offshore tax evasion
(unlike tax avoidance, which is perfectly legal even when aggressive)
is a criminal offence that involves a taxpayer's purposeful intent to
trick a tax authority through the non-disclosure of offshore income or
assets. These data leaks began about 2007, with disclosures from
Liechtenstein and Swiss banks. The first revelations produced, among
other things, the
UBS bank scandal,
in response to which the US Senate held hearings that led to the
enactment of the controversial Foreign Account Tax Compliance Act
(FATCA). FATCA seeks to force non-US financial institutions to divulge
information on the deposits of "US persons," a very broad category that
includes most entities with a US connection as well as individuals who
(though they do not reside in the United States) are considered US
citizens under US citizenship law.
FATCA is problematic,
for a number of reasons. One reason is its coercive nature: unless the
IRS receives sensitive personal financial information about US persons,
including certain Canadian residents, the US government imposes a
punitive withholding tax against foreign financial institutions. The
second and more important reason is the absence of any reciprocity.
The initial leaks of 2007 disclosed only account names and deposit
balances. In 2013, however, there began a series of "mega-leaks" that
found their way to the International Consortium of Investigative
Journalists. These leaks, which involved millions of taxpayer files,
provided much more detail about the activities of the offshore world. In
2012, I began serving as a consultant to the Canadian Broadcasting
Corporation regarding these leaks, explaining the documents to
journalists. Sifting through the files, one could see how advisers set
up inappropriate structures and how "dirty money" was transferred and
invested offshore. For the first time, academics, journalists, and law
enforcement officials were shown a very detailed portrait of the
offshore world, and they saw its links with the illegal drug trade and
with horrific crimes and human rights violations such as child sex
trafficking and illegal organ donations.
What did we learn? We learned, among other things, that the offshore
world benefits not only criminals and multimillionaires but also certain
multinational firms.
For decades, some governments have supported multinationals' use of tax
havens to reduce their global tax liabilities. Certain provisions of the
Income Tax Act, for example, helped multinationals minimize foreign
taxes on business income, allowing these businesses to use financing
affiliates and structures that in some cases achieved a "double dip"
(that is, an interest deduction in both Canada and the relevant foreign
country). This deliberate tax policy, codified in the Act, was designed
to promote the competitiveness of Canadian-based multinationals.
The 2013 leaks revealed the boldness of some multinationals' tax plans,
particularly businesses that had significant amounts of mobile income or
assets. The ensuing media attention, which was sometimes
oversimplified, gave rise to a negative public reaction and prompted
some consumer-facing businesses to address the potentially adverse
reputational consequences. Starbucks, for example, voluntarily increased
its corporate tax payments to the United Kingdom. Apple Inc., on the
other hand, after receiving negative media attention for taking
advantage of the tax regimes of Ireland and the Netherlands (as revealed
by the
"Paradise papers" leak of 2017),
proceeded to use new entities, based in other tax havens, to
restructure its global operations in such a way that it achieved similar
tax benefits.
The
Luxembourg leaks
("LuxLeaks") investigation of 2014 revealed how the Luxembourg tax
authority issued advance tax rulings that were often very favourable to
multinationals. As part of the BEPS reforms, many countries, Canada
included, now exchange tax rulings with other affected jurisdictions.
The leaks revealed, among other things, the various functions that
offshore entities serve. An estimated $2.5 trillion, much of it from the
sale of illicit narcotics, is laundered annually around the globe, and
a lot of this activity takes place in the offshore world. Individuals
who are living under illiberal regimes that have weak commitments to the
rule of law (for example, China, Russia, and Mexico) often fear, with
good reason, that their home governments will seize their domestic
assets and leave their families with nothing. Some of these governments
restrict their citizens to making investments in domestic assets,
prompting these individuals to diversify their investment portfolios and
use offshore entities to anonymize their global investments. The
mega-leaks showed how hundreds of billions of dollars pour out of these
countries for investment in OECD countries such as Canada, resulting in,
for example, skyrocketing Vancouver housing prices.
The World Reacts: Let the Light Pour In
Political reactions to these developments have included efforts to increase transparency.
Preventing Tax Evasion
Today's pursuit of offshore tax evaders has its roots in the 1920s
League of Nations deliberations that produced the first bilateral tax
treaties. A provision within these treaties envisioned the exchange of
tax information as a way to reduce fiscal evasion. An initial limitation
was that most of the early treaties were negotiated between wealthy
capital-exporting nations, such as Canada and the United States. These
treaties often contemplated three types of tax information exchange:
(1) information on request, (2) automatic exchange, and (3) spontaneous
exchange (whereby a tax authority would discover information about a
non-resident and share this information with a foreign tax authority).
Tax evaders, resourceful then as now, took the necessary steps to
counter these measures; they began using tax havens that did not have
information exchange agreements with other countries.
The late 1990s saw a turning point when the OECD's efforts to tamp down
on "harmful tax competition" led to a blacklist of tax haven
countries—that is, countries that did not have effective information
exchange. In 2002, the OECD created a model tax information exchange
agreement (TIEA), which envisioned agreements between OECD countries and
tax haven countries. But the "information on request" basis of this
model was soon found deficient: the resident country usually does not
have sufficient information to make the request in the first place. (The
OECD model protocol to the TIEA, published in 2015, contemplates the
addition of automatic and spontaneous tax exchanges.) Canada has entered
into TIEAs with 24 countries, and it has, in addition, 94 bilateral tax
treaties, many of which have provisions for the automatic exchange of
tax information.
From 2013 onward, the OECD and the G 20 emphasized that the automatic
exchange of tax information needed to be the new global standard, and
this standard is being implemented through the common reporting standard
(CRS). The CRS mandates an "internationally agreed standard" by which
countries require their financial institutions to obtain information on
accounts held by non-residents and—under applicable TIEAs or bilateral
treaties—to automatically report that information to the account
holders' local authorities.
Under this system, Canadian law requires Canadian financial institutions
to identify non-resident account holders and to report specified
information to the CRA, which shares this information with the tax
authority of the country where the account holder resides. Canada's
partners in the CRS provide the CRA, in turn, with information
concerning Canadian residents who have foreign accounts. Armed with this
information, the CRA can check to see whether the Canadian resident has
disclosed all income connected to its offshore holdings. Most developed
countries participate in the CRS, with the glaring exception of the
United States, which rejects the reciprocal exchange of tax information.
Privacy Rights and Challenges
Of course, automatic exchange standards such as the CRS reflect, or seek
to reflect, a balancing of rights—taxpayers' privacy rights on one hand
and, on the other hand, tax authorities' rights to obtain the
information they need to protect the integrity of their nations' tax
laws. But the increase in the collection and cross-border sharing of
taxpayers' so-called big data (large and complex bodies of aggregated
data) has heightened concerns about privacy rights. There are concerns,
for example, that transferred information
- may not be as well protected by the recipient country's laws as it is by the transferring country's laws;
- may be misused by the recipient country for political purposes, such
as helping domestic companies compete against foreign competitors;
- may be misused to sanction taxpayers for political reasons, which could lead to human rights violations;
- may be illegally accessed or altered by third parties; and
- may be misleading or inaccurate, which could lead to foreign investigations that target innocent taxpayers.
As noted above, the United States has refused to participate in the
reciprocal exchange of tax information, opting instead to use FATCA's
coercive withholding provisions to force other countries, including
Canada, to provide the IRS with financial institutions' information on
so-called US persons. In order to override other countries' privacy
concerns, the United States has forced virtually all developed
countries, including Canada, to enter into "intergovernmental
agreements," in a form mandated by the US government. Canada entered
into one of these agreements in 2014 and enacted domestic statutory
provisions to give it the force of law. As a result, Canadian financial
institutions (defined very broadly) have onerous and complex due
diligence requirements to identify and report on "US reportable
accounts." These institutions transmit this information to the CRA,
which then provides it to the IRS. I have learned, through submitting
access-to-information requests,
that Canada provided roughly 1 million information slips a year to the
IRS under the "qualified intermediary" program, and that the CRA, during
the first year of FATCA, provided the IRS with roughly 150,000 slips, a
number that doubled to about 300,000 slips the next year. So far, the
provision of information under FATCA has been non-reciprocal; Canada has
received nothing in exchange for helping the Americans.
Progress?
The
CRA estimates
that in 2014 (before the introduction of the transparency measures
described above), the government lost between $0.8 billion and
$3 billion in tax revenues because of hidden offshore accounts. Have the
measures since 2014 helped Canada collect incremental tax revenues? The
jury is still out on this question. The government, for its part,
claims (and anecdotal evidence tends to confirm) that the CRA is
investigating offshore tax avoidance and tax evasion more aggressively
than in the past. (I am a member of the CRA's Offshore Compliance
Advisory Committee, which is studying the impact of the offshore world.)
Recently, the federal and provincial governments have taken additional
steps to promote tax transparency. These steps include the addition of
beneficial ownership disclosure requirements to the Canada Business
Corporations Act (CBCA) and the elimination of bearer shares from the
CBCA and some provinces' business corporation laws. Canada and the
provinces may need to take additional steps, such as creating a
national registry of the beneficial owners of business and legal entities. The government should also promote the adoption of a
multilateral taxpayer bill of rights,
to ensure the protection of taxpayers. If governments have confidence
that their taxpayers' rights will be respected, they are more likely to
engage in effective exchanges with other countries.
International Tax Planning
In the global response to aggressive tax planning, the main measure to
promote tax transparency has been the development, via the BEPS reform
processes, of CbCR, which in 2018 became law in Canada through
amendments to the Income Tax Act. Under CbCR, large multinational firms
with over €750 million (roughly $1.2 billion) in consolidated global
revenue must disclose all tax (and similar) payments that they have made
to every country where they operate. From an
academic perspective,
CbCR seems to be that rare thing: a no-brainer. It is a measure that
should assist with transfer pricing and other international audits. The
CRA has stated that the information in these reports will be used only
for risk assessment.
In response to LuxLeaks, governments have also, under BEPS action 5,
promised to exchange tax rulings in order to make the system more
transparent. Under this reform, Canada has agreed to provide its
exchange partners with a summary of some of its tax rulings.
The CRA
estimates
that filing errors and non-compliant tax planning by small and
medium-sized enterprises reduced federal tax revenues in 2014 by between
$2.7 and $3.5 billion, and that large corporations improperly avoided
roughly $8 billion in taxes. The government is trying to address this
"tax gap" through the stricter enforcement of tax laws. In recent
federal budgets, the current administration has put an extra $1 billion
toward tax enforcement resources, with most of the monies dedicated to
transfer-pricing audits. A further $600 million was pledged in the
November 30, 2020 fall economic statement. In these audits, the
government has also been more aggressive in its demands for
foreign-based information. Like other governments, Canada is worried
that tax planning is eroding the corporate income tax base, and it
believes that tax transparency measures are among the tools for
protecting the integrity of this tax base.
A New Kind of Tax Practice: Vetting and Managing Tax Information Flows
The new global measures to promote transparency, including CbCR and the
CRS, represent progress in the ongoing battle against offshore tax
evasion and non-compliant, aggressive international tax planning. The
new measures are a good starting point for bringing sunlight, that best
of disinfectants, to the global fiscal and tax system: they will produce
information to assist tax authorities.
What does all of this mean for tax advisers?
The reforms have involved complex new laws and policies that regulate
the collection, use, and disclosure of tax information. These new laws
and policies have created, in turn, the need for professional advice on
the management of tax data. The result is a new (or newish) area of tax
practice, a subspecialty that mixes traditional law or accounting
matters with the complex technology issues related to, for example,
enhanced privacy and data protection needs and the new international
administrative agreements that have arisen in response to the
globalization of personal data.
Technological developments related to tax data include big data, data
analytics, artificial intelligence, and blockchain. Governments
increasingly use these tools to promote tax enforcement. The CRA, for
example, uses a data analytics program to detect undisclosed offshore
income. In response, the Big Four accounting firms (KPMG, PwC, Deloitte,
and Ernst & Young) may react to this development by trying to
reverse-engineer the government's audit technologies to better guard
their business clients against the risk of audit. (For example, a
taxpayer could identify a "red flag" that will get spotted by government
software and take steps to avoid this issue when engaged in tax
planning.) Business taxpayers can also deploy the new technologies to
help manage their tax functions (such as the use of big data and
artificial intelligence to help calculate arm's-length prices), and to
enhance overall efficiency and compliance.
As detailed above, the automatic exchange of big data under the CRS and
CbCR raises concerns about taxpayers' privacy and about governments'
access to trade secrets and other commercially confidential information.
Therefore, tax advisers practising in this area need to have an
understanding of privacy and data protection laws that goes beyond the
Income Tax Act; they need to be equipped to discern, for example,
whether a client's data were lawfully collected. A relevant statute in
this regard, for instance, is the Personal Information Protection and
Electronic Documents Act, which governs how information is collected in
the private sector and mandates that businesses must receive a
customer's consent before collecting that individual's personal
information. Another statute, the Privacy Act, governs how federal
government agencies, such as the CRA, can lawfully share personal
information, including taxpayer data, with other agencies. When should a
taxpayer accede to a tax authority's or other government official's
demand for information? Should the government, in its efforts to secure
taxpayers' information, be able to rely on tax data stolen during data
leaks? As governments seek ever more access to tax information,
taxpayers, not surprisingly, are increasingly concerned with maintaining
solicitor-client privilege in dealing with their legal advisers.
A final area of concern for tax advisers is the intricate new global tax
administration agreements that are being overlaid on an already complex
system of law. The administrative agreements that govern the CRS and
CbCR help determine what data can be legally collected and what privacy
and technology protections must be in place before any cross-border
exchange of information can occur. Tax advisers need to vet these
agreements and determine whether the taxpayers they serve will require
new cross-border business structures in order to remain compliant. In a
world where data is the "new oil," tax advisers are increasingly called
on to promote and protect their clients' interests by advising on the
collection, use, and disclosure of tax information.