International Tax Transparency

Arthur Cockfield, Queen's University Faculty of Law

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.

Perspectives on Tax Law & Policy
Volume 1, Number 4, December 2020
©2020, Canadian Tax Foundation