Taxation of Capital Gains - international-tax-law.at · income (income is the increase in a person s wealth over two points of time) Hence does not matter whether income is revenue

Australian School of Business

Australian School of Taxation and Business Law

www.atax.unsw.edu.au

Taxation of Capital Gains: (Class 5)

Chris Evans

Australian School of BusinessObjectives

• Review rationale for taxing capital gains (CGs);

• Consider global trends in taxing CGs;

• Identify key similarities and differences in how CGs are taxed around the world;

• Seek to explain (or understand?) why some countries do not have a CGT (the NZ enigma); and

• Suggest some design issues which may shape the CGT in those countries (such as NZ) which may be considering its introduction

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CGT – what is it and why tax it?

• A tax that is imposed upon “a non-recurring gain which is not part of the normal stream of income involved in a business or investment” (Ault and Arnold)

• It is an accretion to wealth, and therefore reflects an increased ability to pay and so should form part of the income base

• Based on the Schanz-Haig-Simons notion of comprehensive income (income is the increase in a person’s wealth over two points of time)

• Hence does not matter whether income is “revenue” income (salary, business profits, rent) or “capital” income (dividends, interest, capital gains): all income is taxable….

• “a buck is a buck is a buck” – Carter Report, Canada, 1966• and so capital gains should be taxed just as other forms of

income should be taxed Reading 9 (OECD) Presentation: M Gattaz


Global trends in taxing capital gains: CGT regimes have become ever more widespread

• First regime for taxing CGs in Norway 1911; followed by USA 1913

• Japan 1946; Denmark 1958; Sweden, Portugal, UK 1960s; Canada, France, Ireland, Spain in 1970s; Australia 1980s, South Africa 2001

• More recently introduced in Egypt (2015) and Sri Lanka (2017)

• Second most widely introduced taxing regime in last 50 years (after VAT/GST)

• But NB still no formal taxation of capital gains in Barbados, Hong Kong, Malaysia and …….New Zealand

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Taxing capital gains in OECD countries

Number of countries

with

1999 (24 countries)

2010(30 countries)

2017(35 countries)

CGT 23 29 34


Spread of CGT regimes 2017 (2014)

Region Number of countries

with a CGT system,

or where CGs

included in income

Number of

countries with a

business CGT

system only

Number of

countries without a

CGT system, or

where information

is not available

Africa 48 (41) 4 (4) 1 (9)

Americas 33 (33) 2 (4) 15 (12)

Asia 40 (29) 5 (11) 6 (9)

Europe 38 (35) 5 (3) 4 (10)

Oceania 12 (6) 0 (1) 7 (12)

Total 171 (144) 16 (23) 33 (52)

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Arguments for taxing capital gains1. To promote horizontal equity

• Capital/wealth confers taxable capacity which should be taxed just as other taxable capacity (eg other income or consumption) is taxed

• Tax systems should be fair, and should be perceived to be fair

2. To promote vertical equity

• Capital/wealth taxes may diminish or constrain wealth and income inequalities

• Particularly so with heavy and progressive annual wealth taxes or death and gift taxes or CGTs

3. To promote efficiency

• Economic distortion apparent when gains not taxed

• positive incentive to utilize assets that would otherwise be under-used

4. For tax system integrity

5. Simplicity? No, but….

6. To raise revenue? Yes, but……..


Revenue from taxing capital gains

1. Typically not very significant amounts of revenue are raised (though difficulties in determining actual revenue: see OECD Revenue Statistics)

2. Volatile revenue which generally accounts for less than 5% of all tax receipts – but NB important integrity role

3. In Australia currently affects roughly 1m taxpayers (mainly individuals) – about 10% of all taxpayers

4. Contrast the UK – only 250,000 taxpayers: roughly 1% of all taxpayers (role of AEA)

5. But critically its role is not to raise revenue – it is essentially an integrity measure

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Defining capital gains – andhow to tax them

• “Taxation of capital gains is one of the most difficult issues in tax theory and in tax practice” (IMF 1991)

• The term "capital gain“ has a very specific and limited meaning under the domestic law of some countries, and no meaning in others

• Hence major variations in practice


Variations in the treatment of capitalgains

• Common law countries (other than US) No tax on gains and/or

Personal gains taxed at favourable rate and/or

Full taxation of business capital profits

• Civil law countries Business profits taxed and/or

Selected personal gains taxed and/or

Use of Dual Income Tax systems

• US system Full integration with income tax

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Australian School of BusinessMethods of taxation of gains

• Tax at normal income tax rates (whether business or personal)

• Tax at normal tax rate, but indexing the asset's cost base for inflation

• Tax investment gains at lower rate, but tax non-investment gains at normal rate

• Tax gain on the sale of long-held assets at a lower rate

• In a global tax system, include the gain, or only part of the gain, in the taxpayer's income

• In a schedular tax system, treat personal-asset gains under a separate schedule at flat rate; or impose a separate capital gains tax

Australian School of BusinessSummary from global trends

• The tax is ubiquitous

• There is no single correct way to tax capital gains; CGT is an unprincipled tax (more so than any other tax)

• Its pragmatism can be an advantage: can be customised to reflect local cultural and institutional requirements

Reading 10 (Evans/Krever) Presentation: P Khodakovsky

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Does NZ need a CGT?• Existing regime, bolstered by 2015 Bright-Line test

legislation, may be sufficient?

• But at best this is partial (a mongrel regime): yet another patch on an increasingly motley set of patchwork provisions

• Most (not all) NZ reviews and reports (Ross, 1967; McCaw 1982; Tax Review 2001; TWG 2010) conclude that there is a strong case, in principle or in theory, for a CGT but either the timing is not right or they see too many practical obstacles

• TWG Final Report 2019 proposes CGT

Australian School of BusinessDoes NZ need a CGT?

• International organisations strongly suggest NZ needs CGT: for example OECD (2000)• Absence erodes tax base and is major weakness of NZ tax system

• Many adverse consequences (narrow base; allocation of savings and investments distorted; tax-shifting behaviour is encouraged [especially for HNWIs]; non-level playing field is created among different financial instruments)

• OECD 2013: CGT would facilitate a more efficient and equitable tax structure (and grave concerns expressed about exacerbation of wealth inequality / encouragement of speculative housing investment / undermining of housing affordability)

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Australian School of BusinessDoes NZ need a CGT?

• Domestic and international academics concur on equity and efficiency grounds, and point to related arguments

• Absence runs counter to broad base, low rates mantra

• Ageing population and rising national debt issues

• NZ is the only OECD country without any form of capital or wealth taxation (Table 6-1 of text). All others have at least one form of annual wealth tax, capital transfer tax or capital gains tax; most have two or three; and three have all four types of such taxes


So why hasn’t NZ got a CGT?Griffith suggests the NZ reluctance to implement a CGT may be down to the interweaving of a number of culturally specific and path dependent factors:

• Strong tradition of taxing land

• Taxing capital is antithetical to needs of the country

• Rejected for practical reasons – high levels of complexity, compliance costs, inefficiency and distortion

Each reason is entirely plausible, but cannot explain. The same issues have existed in many other countries and yet they have introduced CGTs

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So why hasn’t NZ got a CGT?

• Reasons for absence may lie in the realms of political economy: capital and wealth taxation always politically unpopular – but again, this hasn’t stopped them elsewhere

• Perhaps lack of public support, based upon public misunderstandings of the nature of the tax?

• The power of vested interests?

• The lack of a political champion (Jacinda, are you the new Roger?)


Conclusions• Surprising that NZ has relinquished its first mover

status in this aspect of taxation

• But being last mover offers wonderful opportunities to borrow from the best around the world and customise as appropriate

• The time is probably ripe but entrenched political and vested interest opposition, combined with public misunderstanding, make it less than certain it will happen despite pressures on the public purse, diminishing CIT and PIT bases, wealth inequality and housing affordability issues

• Hence…..

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Conclusions

There may need to be some sort of major external or domestic economic or financial shock to act as the catalyst to break the log-jam

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Tax compliance

Class 6

Chris Evans

Australian School of BusinessTax compliance: Overview

1. The tax gap– What is it?

– Why measure it?

– How best to measure it?

– Some country examples

2. Distinguishing evasion, avoidance and mitigation

3. Tackling non-compliance (avoidance)

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1. The tax gap• The difference between the tax that is collected and that which

should have been collected; that is, between the theoretical tax liability and actual tax collected

• Theoretical tax liability is the estimated total tax that is due if all liable citizens and businesses fully complied with all their tax obligations according to the relevant tax legislation

• Actual revenue is known for a given time interval (typically a fiscal year)

• But whose view of the total tax that is due prevails? Taxpayer or revenue authority?

• Also major difficulties of measurement


Source: IMF 2015

Tax Gap

Taxexpenditures

Tax leakage from activity in theinformal/ hidden economy is part of this gap.

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Australian School of BusinessTax gap

Note that non-compliance (giving rise to the tax gap) can arise as a result of many different forms of behaviour:

• Errors

• Failure to take reasonable care

• Non-payment

• Differences in legal interpretation

• Avoidance

• Hidden economy and evasion Reading 12 Presentation (Schneider & Buehn): O Ruidant

• Criminal attacks

Australian School of BusinessThe purpose of estimating and analysing tax gaps?

For revenue bodies, tax gap analysis & estimation can help to explain:

What do overall compliance trends look like over time? Are our strategies having an impact?

Demonstrate accountability for proper execution of responsibilities.

Sources & causes of tax non-compliance for determining more effective strategies to address non-compliance.

Whether risk assessment processes require enhancement.

Whether legislative changes may be required

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The purpose of estimating and analysing tax gaps?

Tax gaps are important to others:– Government:

Overall health of the tax system

Are revenue-raising objectives being met?

What potential exists for revenue mobilisation?

– Ministry of Finance/ Treasury:

Is the policy design and its administration effective?

What enhancements can be made?

– Taxpayers/voters:

Is the tax system being administered competently?

Are most taxpayers properly complying?7


The methodologies used to estimate and analyse tax gaps

• ‘Top down’ (macro) methods− Use aggregate (external) data that is compiled

externally and independently of the tax body, that can be applied directly or indirectly to estimate the taxable base for a tax.

− Statistical calculations based on broad observations.

• Bottom up (micro) methods− Management Information from normal

operational programs: Data warehouse and risk engine

− Data matching (internal and external sources)− Random audit enquiries to complement

management information− Illustrative data from operational experts

• Tax gaps are estimated tax-by-tax, ideally using a combination of methods; in some countries they are aggregated to derive a total tax gap estimate.

Top down (indirect)

approaches

pp

Bottom up (direct)

approaches

Estimation of tax gaps

Used largely for

indirect taxes

Used largely for

direct taxes

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EXAMPLE: Estimating the tax gap for a good & services tax (GST)

Assess the total amount of expenditure in the economy that is theoretically liable for GST

Estimate the tax liability on that expenditure based on commodity breakdowns of the expenditure data

Deduct any legitimate reductions in the GST liability occurring through schemes & reliefs to

arrive at the GST theoretical tax liability

Deduct actual GST receipts for the fiscal year under examination

Assume that the residual element- the gap- is the total GST loss due to any cause, including non-

compliance, illegal avoidance and fraud

less

less

equals

Takes account of different tax

rates, exemptions, etc

Uses national accounts data on personal consumption expenditure

Reliefs such as the registration

threshold

Methodology is usedwidely for VAT gap

estimation purposes, Including by EU, ATO,

Chile, and UK.


Revenue body attitudes & approaches to tax gap estimation

• Relatively few countries, and their revenue bodies, have a comprehensive gap research program.

• Historically, tax gap research had many opponents:Methods are too imprecise.

Don’t produce useful and/or timely information.

We know our risks and have them under control!

Or was it a fear of the unknown; possibly having to explain poor outcomes?

• Proponents (e.g. Denmark, UK, & USA) argue for their benefits.

• Interest in gap research has grown significantly in last decade.

Until fairly recently,

Australia & Canada

were in this camp

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Tax gap estimation findings- European Union countries

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Chart 1. Estimated VAT gaps in EU countries (2014)

VAT gaps vary enormously across EU member countries, reflecting widely varying attitudes to complying with tax laws, differences in administrative competence, & tax system design weaknesses. For 2014, the average tax gap was 14.1% & the estimated revenue foregone was EUR159 bn.

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Source: CASE (2017)

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Measuring tax gaps: UK approach and findings

• UK HMRC conducts ongoing gap study for all taxes administered.

• Produces and publishes annual report of findings and methods.

• Provides gap trend data for all taxes, by customer segment, and by type of underlying behaviour.

• Methodologies independently evaluated and endorsed by IMF (2013).

• Leading exponent of tax gap research.

Sources: HMRC (2018) and IMF (2013)

Australian School of BusinessMeasuring tax gaps: UK findings

A story of improving

compliance over time.

Improvements can be traced back to reform of UK tax administration in 2005, with merger of separate direct & indirect tax administrations, & ongoing legislative & administrative reforms in subsequent years.

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Measuring tax gaps in Asian economies

Bangladesh• World Bank study in 2014 on VAT tax gap for years 2010 to

2013.

• Gap estimated at 62% for 2010 and declining progressively to 56% in 2013.

China, PRC • Comprehensive program in State Administration of Taxes

(SAT) covering both direct and indirect taxes.

• VAT gap research for 2001 to 2009 revealed improving compliance, with tax gap declining from around 40% to 25% for the period covered.

Philippines • Joint revenue body/ IMF study in 2011 to 2015 of Philippines’

VAT tax gap.

• Study for 2008/2015 reveals marginally declining gap, estimated at 38% (2015)


Tax gap research- the state of play

• Tax gap research approaches are not widely applied by national tax bodies although their use has grown over the last 6/8 years

• Strongly advocated by IMF, EU, and many national audit bodies• Tax bodies using tax gap research include Australia, Canada,

Chile, Denmark, Finland, Mexico, Sweden, UK & USA• Some tax bodies undertake tax gap research but do not publish

results• Virtually no interest in tax gap research from tax bodies in Asia • Non-use of tax gap research appears to result from a range of

factors: Weaknesses in accountability & managerial competence; Cultural objections; Fear by tax body officials that tax gap will be used as a performance

measure; Concerns for costs of random audits & political pushback; and Lack of familiarity with how to undertake such research

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2. Distinguishing evasion, avoidance and mitigation (1)

Evasion • “illegal arrangements through or by means of which

liability to tax is hidden or ignored …[such that]… the taxpayer pays less tax than he is legally obligated to pay by hiding income or information from the tax authorities” (OECD) Eg omission of taxable income or over-statement of

deductible expenses Eg VAT carousel fraud But NB not always criminal: may be innocent

error rather than dishonesty



Avoidance• “an arrangement of a taxpayer’s affairs that is intended to

reduce his liability and that although the arrangement could be strictly legal it is usually in contradiction with the intent of the law it purports to follow” (OECD)

• AKA Aggressive tax planning (ATO)

Impermissable/abusive tax avoidance (SARS)

Unacceptable tax avoidance (HMRC)

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Mitigation“concerned with the organisation of a taxpayer’s affairs (or the structuring of transactions) so that they give rise to the minimum tax liability within the law without resort to…impermissible tax avoidance…” (SARS 2005)


3. Tax Avoidance

• “an arrangement of a taxpayer’s affairs that is intended to reduce his (sic) liability and that although the arrangement could be strictly legal it is usually in contradiction with the intent of the law it purports to follow” (OECD)

• Highly contentious, particularly at the moment as a result of high profile MNC and HNWI activity (and BEPS etc responses)

• Within the letter of the law but contrary to its spirit

• All in the eye of the beholder: “If a firm has an opportunity to structure its operations in a tax efficient

manner, it has a responsibility to its shareholders to do so” (Blouin, NTJ 67(4) 2014, p. 878)

“Large accountancy firms advise multinational companies on complex strategies and contrived structures which do not reflect the substance of their businesses and are instead designed to avoid tax” (UK House of Commons Committee of Public Accounts, Report 28 Jan 2015)

Reading 11 (Donohue et al) Presentation: D Brodskiy

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Anatomy of avoidance: goals

• Elimination

• Deferral Relies on time value of money

• Re-characterisation Eg conversion from highly taxed item (revenue) to less

heavily taxed or non-taxed item (capital)

• Shifting Income/profit shifting

Value shifting

Australian School of BusinessAnatomy of avoidance: hallmarks

• Lack of economic substance

• Use of tax indifferent accommodating parties/SPEs

• Unnecessary steps and complexity

• Inconsistent treatment for tax and financial accounting

• High transaction costs

• Fee variation clauses/contingent fees

• Use of new complex financial instruments

• Use of tax havens

(SARS, 2005)

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Growth of avoidance activity?

• Development from boutique (mid 20th century) to mass marketed (late 20th century)

• Signs of slowing in large retail market in early 2000s (response to US tax shelter scandals, Australian mass-marketed schemes, similar developments around world)?

• Tax haven loss estimated at US$50 billion per SARS (2005), and UK avoidance estimated at £25 billion 2008 (TUC); more recently OECD/G20 suggest annual losses may be US$100 to US$240 billion

• Resurgence in “aggressive” activity in last 10 years, with many public “scandals” involving household names including Apple, Vodaphone, Starbucks, Google, Fiat, Caterpillar, Glencore and a host of others


Reasons for the growth

• Globalisation, deregulation, market forces

• Supply side factors Role of promoters (financial institutions/Big Four) Computer and telecom/technology advances Availability of talented human resources

• Demand factors Changing appetites Changing levels of acceptability Tax is a cost of doing business, and like all costs, attempts will

be made to minimise the tax cost

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Reasons for concern

• Negative impact on revenue collections and resulting social and political difficulties that can bring

• Efficiency costs (siphoning off resources from more productive ventures)

• Loss of equity – distributional impact

• Increased complexity of the tax system as a result of administrative and legislative response


Responding to the problems of avoidance

• Administrative responses (national/unilateral and international/multilateral)

• Legislative responses (unilateral/national)

• Judicial responses (primarily unilateral/national but NB ECJ)

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Administrative responses: national/unilateral

• Moved well beyond command and control

• Now cooperative compliance, responsive regulation and meta-risk management

Disclosure (real time intelligence; EoI)

Transparency (compliance plans; CbC reporting)

Cooperation (ACAs)

Proportionality (risk to revenue) (RDF/risk profiling)

Certainty


Administrative responses: international

• OECD work on havens and harmful tax competition late 90s onwards

• FTA Seoul Declaration 2006

• FTA Study into role of intermediaries 2008

• JITSIC 2004 onwards

• Tax Information Exchange

• BEPS program 2013 onwards

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Tax avoidance- the OECD’s BEPS project

• BEPS- a G20 sponsored anti-avoidance initiative launched in 2013

• Seeks to modernise the international tax rules for a globalised world

• Aim: Make major in-roads to annual tax losses of $US 100-240 billion

• Work led by OECD CTPA, under Committee on Fiscal Affairs, with extensive country input

• Summary of proposed measures approved by G20 in November 2015

• Measures seek to achieve reduced avoidance/ better compliance by: – improving the coherence of tax rules across borders: – tightening substance requirements; and – ensuring increased transparency and certainty

• Some external scepticism that proposals will be adopted, including by USA


Tax avoidance- the OECD’s BEPS project

• Proposed measures address matters such as hybrid mismatches, limiting interest deductions, preventing treaty abuse, improving PE rules, enhancing transfer pricing rules, disclosure of aggressive transfer pricing, dispute resolution, & multi-lateral instrument to adjust bi-lateral treaties.

• Implementation of the plan requires a co-ordinated round of in-country legislative changes and cross-border actions which is now underway.

• “Inclusive Framework” set up to enable OECD & G20 countries and others to work together to develop standards on BEPS-related issues, and to review and monitor the implementation of the BEPS package. Over 120 countries now participate.

Chances of success?

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Legislative barriers to avoidance

• Specific anti-avoidance measures

• General anti-avoidance rules

• Scheme/product disclosure rules

• Promoter penalty regimes

• Principles based drafting


Judicial responses to avoidance

• Mixed fortunes for revenue and taxpayers

• No greater certainty of outcome

Contrast Mathew, Barclays Mercantile and Peterson

• Greater certainty of approach

Contextual and purposive

• Some convergence?

• Also NB ECJ and Apple etc

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Australian School of BusinessAvoidance: Do we have a problem?

1. Developed countries rely very heavily on the income tax base

2. In particular, Australia is heavily reliant• PIT is 39% of total tax revenue (TTR)• CIT is 19% of TTR• And consumption taxes are only 27% of TTR

3. Hence nearly 60% of TTR in Australia comes from the income base


1965 1975 1985 1995 2005 2014

PIT 26 (34) 30 (44) 30 (45) 26 (41) 24 (37) 24 (39)

CIT 9 (16) 8 (12) 8 (10) 8 (14) 10 (23) 9 (19)

SSC 18 (-) 22 (-) 22 (-) 25 (-) 25 (-) 26 (-)

Payroll 1 (3) 1 (6) 1 (5) 1 (7) 1 (5) 1 (5)

Property 8 (11) 6 (9) 5 (8) 5 (9) 6 (9) 6 (10)

Consumption 36 (35) 31 (29) 32 (32) 32 (29) 31 (27) 31 (27)

Other 2 (1) 2 (-) 2 (-) 3 (-) 2 (-) 4 (-)

Tax Mix: OECD Averages 1965-2014 (Australia in red in brackets)

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Australian School of BusinessDo we have a problem?

1. Developed countries (and Australia in particular) rely very heavily on the income tax base

• PIT is 39% of total tax revenue (TTR)

• CIT is 19% of TTR

• consumption taxes are 28% of TTR

2. The CIT base in particular will become ever harder to tax as a result of many (perfectly legitimate) profit shifting strategies by MNCs as we continue to shift from a smokestack economy to a digital economy

Australian School of BusinessDo we have a problem?

1. Developed countries (and Australia in particular) rely very heavily on the income tax base

• PIT is 39% of total tax revenue (TTR)

• CIT is 19% of TTR

• consumption taxes are 28% of TTR

2. The CIT base in particular will become ever harder to tax as a result of many (perfectly legitimate) profit shifting strategies by MNCs such as Apple, Glencore, Google, Vodaphone, Starbucks, Fiat etc

3. BEPS reflects this concern big time

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What is the problem?• The prospect of an ever diminishing corporate tax

base as a result of mobile global capital (combined with stresses on the personal income tax base as a result of globally mobile labour and an ageing population)

• This constitutes a serious long term risk to revenue• The risk to revenue is compounded by loss of tax

sovereignty and perceptions of an unfair tax system

• As a result a tax architecture that was designed for a bygone era is perceived to be no longer fit for purpose

Australian School of BusinessWhat can be done about the

problem?

• Do nothing

• Move house

• Renovate

• Re-design and re-build

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The “Do nothing” option?

• Fits with the ‘smaller government’ mantra, but…

• If “tax is the price we pay for a civilisedsociety”, doing nothing may lead to other (perhaps painful) social consequences

• Doing nothing in the corporate space may certainly have knock-on effects for tax compliance elsewhere


Moving house?

1. Downsizing

2. Shifting bases• The consumption tax option?• Tax the shareholders?• The under-utilised wealth tax base?

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Australian School of BusinessRenovation?

• The OECD/G20 BEPS approach

• Improve tax system integrity through• tighter residency, transfer pricing, thin capitalisation

and CFC rules

• better GAARs

• improved information exchange

• Essentially unilateral/bilateral

• Always playing catch up


Re-design and re-build• A more radical solution: formulary

apportionment

• Requires multilateral action

treat MNCs as a single entity

submission by MNCs of one global profit report to all countries in which they operate

allocation of taxable profits to the countries where business activities are conducted on a pre-determined basis (sales/physical assets/employees)

each country then sets own tax rates and competes for capital on the basis of those

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Third party contract

manufacturers(China)

In-country distribution companies

(e.g. Australia)

Apple Sales International

(Ireland)

Apple Operations International

(Ireland)

Apple IncSales to markets in Americas

100%100%

100%

One single enterprise

Sales to markets in Europe and Asia

Apple Operations Europe(Ireland)

100%

100%Finished products

Finished products


Conclusions• There is no single magic pudding or silver bullet

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Conclusions• There is no magic recipe or silver bullet

• Accept that the tax mix may need to change somewhat (consumption; land & resources)

• but…



• Accept that the tax mix may need to change somewhat (consumption; land & resources) but…

• CIT base may be hard to tax but that is no justification for not continuing to tax it and it will continue to be an important base

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• OECD G20 BEPS initiatives may help (though I have doubts)






• But ultimately a paradigm shift in international taxation from futile national attempts to tax separate legal entities to one which taxes:

• single global enterprises

• on a pre-determined share of consolidated global profits

• at a national level

• with competition on the basis of rates at that national level

will have to take place, notwithstanding:

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• But ultimately a paradigm shift in international taxation from futile national attempts to tax separate legal entities to one which taxes single global enterprises at a national level on a pre-determined share of consolidated global profits with competition on the basis of rates at the national level will have to take place, notwithstanding:

the inertia effect of the existing rules (including information and resource asymmetry between MNCs and revenue authorities)

the power of the MNCs to resist change

the ambivalence (and hypocrisy) of governments




Any questions?

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Australian School of BusinessComparative Tax Systems

Tax complexity and tax operating costs

Class 7

Chris Evans

https://www.youtube.com/watch?v=sBltrX4gCbk


OVERVIEW

1. What do we mean by complexity/simplicity in the context of the tax systems?

2. How do we know our tax systems are complex?

3. What causes the complexity?

4. What can we do about it?

But first……

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1. Some opening thoughts• “Simplification is the most widely quoted but least widely

observed of the goals of tax policy”Surrey & Brannon (1968)

• “To say that one is in favour of tax simplification is tantamount to stating that one is in favour of good as opposed to evil”

Cohen, Stikeman & Brown (1975)

• And yet until recently – at policy-making and at the political levels – only lip-service has been paid to tax simplicity and simplification

• Subsequent interest in last 40 years may be due to spread of GST/VAT and rise of awareness of compliance costs

Australian School of BusinessInitial questions

• Does it matter if a tax system is complex?

• What are the adverse effects of complexity or excessive complexity?

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Australian School of BusinessAdverse effects of excessive complexity

• Intentional and non-intentional non-compliance

• Tax revenue losses

• Deadweight losses

• Indirect GDP losses

• Equity


1. The meaning of complexity/simplification

• Tax complexity/simplicity is itself a complex concept

• One approach is to interpret tax complexity in terms of tax compliance: tax complexity means tax compliance is difficult

• Need to understand what is meant by tax compliance

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The operational approach to compliance (OECD, 2004: 7) (i) “registration in the system;

(ii) timely filing or lodgment of requisite taxation information;

(iii) reporting of complete and accurate information; and

(iv) payment of taxation obligations on time”

Tax complexity usually refers to (ii) and especially (iii) above



The conceptual approach to compliance (James and Alley, 1999: 32)

• “the willingness of individuals and other taxable entities to act in accordance with the spirit as well as the letter of tax law and administration without the application of enforcement activity”

To voluntarily act in accordance with the letter and spirit of tax law and administration may not be easy (willingness vs. knowledge)

Tax avoidance: taxpayers act in accordance with the letter but not the spirit of tax law and administration. Is tax avoidance consistent with tax compliance? The line between acceptable and aggressive tax planning can be blurry.

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Tax complexity is therefore

multidimensional

interactive (taxpayer behaviour responses)

relative (more complex rather than complex)



Different types of complexity (Evans & Tran-Nam 2010)

• Policy complexity refers to the complexity that arises from incorporating policy intentions into tax laws

• Statutory (or legislative) complexity refers to the difficulty by which a tax law can be read, understood, applied and resolved in various practical situations

• Procedural (or administrative) complexity refers to the difficulty by which tax administrative requirements can be met by taxpayers and tax administrators

• Compliance complexity refers to the complexity faced by taxpayers when they respond to the tax law requirements

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2. Indicators of complexity

• How do we know if our tax system, or any tax system, or any part of any tax system, is complex? If you were asked by the Finance Minister, a politician, or a media commentator to provide evidence of tax system complexity, what sort of evidence would you use? What are the indicators of tax system complexity?


2. Indicators of complexity• Widespread community concern

• A number of proxies

Number of taxes Number of reliefs (OTS: 1,042 Nov 2010) Number of pages of legislation Readability of legislation (Flesch; Cloze) Frequency with which legislation is changed Use of tax agents Number of administrative obligations (SCM) Number of requests for rulings Levels of litigation etc

• The operating costs of the tax system

• Trade off: meaningful indicator vs accurate measure

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Australian School of BusinessWhat are operating costs?

Administrative costsplus

Compliance costsequals

Operating costs

Australian School of BusinessAdministrative costs: What are they?

• Administrative costs are the public sector costs to the government (ultimately borne by taxpayers) of administering and collecting taxes

• Usually comprise the costs of running the revenue authority

• But NB many costs often not counted eg Capital costs on buildings etc

Costs of developing tax legislation

Costs of tax dispute litigation and resolution

• Usually between 0.5% and 2% of revenue yield, depending on taxes

• Usually between 20% and 50% of compliance costs

• Note relationship between compliance costs and administrative costs (usually inverse)

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Australian School of BusinessCompliance costs: What are they?

• Compliance costs are the costs (monetary and time) that taxpayers incur in complying with the tax system

• They are approximately the costs that would disappear if the tax disappeared

• Usually comprise Value of time spent by taxpayers/unpaid helpers on

complying

Monetary costs spent on tax advisers

Incidentals (postage, software, travel etc)

Psychological? (stress, anxiety etc)

Australian School of BusinessSome formulas

• Tax compliance costs = Tax computational cost + Tax planning costs= Inevitable costs + Preventable costs= Monetary costs + Psychological costs= Transitional costs + Recurrent costs

• Social tax compliance costs (costs to society) = Opportunity costs of resources expended – Managerial benefits

• Taxpayer compliance costs (costs to taxpayers) = Social tax compliance costs – (Cash flow benefits + Tax deductibility benefits + Cash subsidies from the government)

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Australian School of BusinessResearch into operating costs

• 1970s: the “hidden” costs of taxation

• Research has flourished in last 40 years

• Over 100 major studies since 1935 National and (less so) cross national

Developed and (less so) developing nations

All taxes and all types of taxpayer

Variety of methodologies: primarily quantitative paradigm (survey and modelling), but increasingly qualitative approaches also being used


How are business taxpayer compliancecosts measured? An example

TCC = Nkl[ECkl + ICkl] Nkl0.5(1+pkl)tkl[ECkl + ICkl]

CBkmwhere

TCC = business taxpayer compliance costs

k = business sizes (small, medium, large)

l = legal form (sole trader, partnership, trust, superannuation fund, company)

N = total number of business taxpayers in that category

t = average marginal tax rate

EC = average external tax adviser costs

IC = average internal labour costs

p = proportion of taxable business taxpayers in that category

m = tax types/collection mechanisms

CB = cash flow benefits/costs

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Australian School of BusinessWhat the research tells us

• Tax compliance costs are significant and high: 2%-10% of revenue yield

Up to 2.5% of GDP

A multiple of 2 to 6 times administrative costs

• Tax compliance costs are extremely regressive SMEs carry disproportionately high compliance costs Particularly VAT/GST Caused by diseconomies of scale/high fixed

costs/learning curve effectReading 13 (KPMG/EC) Presentation: J Bilgram

• Tax compliance costs are not diminishing over time

Australian School of BusinessEU research

• European Tax Survey (WP3/2004)

• Data from 700 companies in 14 member states

• Confirmed significance and regressivity:

average of €1.5m for large co’s (2% of taxes paid and 0.02% of sales)

average of €200k for SMEs (31% of taxes paid and 2.6% of sales)

• Cross-border activity leads to higher compliance costs

• Transfer pricing major difficulty in CT area

• Repayments and refunds major difficulty in VAT area

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Australian School of BusinessMeasuring complexity: Another way

• Over recent years the World Bank has been conducting an annual measurement of the “ease of doing business” (the Doing Business project)

• Doing Business measures business regulations

• Designed to compare regulatory environments across economies

• Promotes the introduction of more efficient regulation

• “Paying Taxes”, undertaken by PWC each year, is one of 11 areas of regulation evaluated in Doing Business, estimating the “ease of paying taxes” (others include “Starting a business”; “Getting credit”; “Trading across borders”; “Employing workers” etc)

Australian School of BusinessAbout the Paying Taxes report

• The Paying Taxes report provides further analysis of the tax data included in Doing Business

• Provides data which can be compared on a like-for-like basis, and now (2019 based on 2017 data) over a 14 year period

• Facilitates a comparison of the worlds tax regimes (190) from the point of view of companies paying taxes

• Assesses the rate of tax and cost of complying with tax systems

• Raises awareness of all of the taxes contributed by companies as well as corporate income tax

• Provides information to help inform policy decision making and tax reform

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Methodology of Paying Taxes: The three sub-indicators

CE1


Selected outcomes (2017 report)Country Overall

rankingTotal tax rate

(%)Time to comply (hours)

Number of payments

Australia 39 47.3 105 11

Austria 72 52.0 166 12

Canada 9 21.0 131 8

France 95 66.6 137 8

Germany 68 48.8 218 9

Hong Kong 4 22.8 78 3

New Zealand 23 34.4 152 8

UAE 1 14.8 12 4

UK 16 33.7 110 8

United States 47 43.8 175 11

Venezuela 188 65.5 792 71

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Folie 23

CE1 Chris Evans; 10.04.2019

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Key changes in recent reports

• A fourth indicator (Post filing index) has been added (2016) to provide insights into the tax compliance burden that a business may face once it has filed its tax return. Uses two measures: obtaining a VAT refund and amending a corporate tax return.

• 2019 Report (based on 2017) shows (global averages)Total Tax Contribution Rate: 40.4% (same as previous year)

Time to comply: 237 hours (down 2 hours from previous year)

Number of Payments: 23.8 (down 0.2 from previous year)

Post filing index: 59.6 (S America = 42; Africa = 56; N America = 59; EU and EFTA = 82.4)

• Global average results virtually same as previous year, despite 113 of the 190 countries recording tax reform


Limitations of the Paying Taxes approach

• The Paying Taxes study is based on a case study company to facilitate a global like for like comparison, it

is not a representative company,

does not take into account regional variations across a country,

does not cover all aspects of an economy’s business environment,

does not cover the full range of taxes or tax activities in a country

• The study assumes the company is in the formal sector

• The indicators only measure how easy it is to deal with tax compliance up to submission of the tax return with limited indication of post filing activity

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3. Sources of tax complexity

Brainstorm

What causes tax compliance costs to be so high?

What are the sources or drivers of tax complexity in the tax system?


3. Sources of tax complexity

• Within the control of the government (number of taxes; over-use of elections and choice for taxpayers; protection of tax revenue; use of tax law for non-revenue policy objectives; distinction between taxes and transfers; broadening of tax base; frequency of tax law change; tax law drafting, including undefined and ill-defined boundaries and classifications; minimisation of revenue losses; judicial tradition)

• Partly within the control of the government (adversarial tax culture; growing complexity of the economy); and

• Outside the control of the government (household preference for tax liability minimisation; tax practitioner preference for complexity; aggressive tax planning; size of the business; international tax transactions)

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4. Addressing tax complexity

Reading 14 (Smulders and Evans) Presentation: W Egger


4. Addressing tax complexity Tax policy responses

• Adjusting tax policy settings judicious use of thresholds (eg increased VAT) simplified rules for calculating liabilities elimination of special preferences elimination of number of rates and taxes harmonisation of tax bases and rates

• The equity-simplicity trade off consider implications of choice deduction simplification for personal taxpayers

• The administrative cost-compliance cost trade off inverse relationship potential

• Less frequent change and more consultative change

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4. Addressing tax complexityTax administrative responses

• Re-engineering government processes

eg SBR

Reduced filing

• Implementing taxpayer-centric approaches

eg dedicated organisational units

• Leveraging advances in technology

eg machine to machine transactions

• Optimising use of third party information

eg pre-filling

• Re-designing compliance interventions

eg risk management approach

Australian School of Business4. Managing complexity: ten principles

1. Accept justifiable complexity

2. Accept rough justice

3. Focus on low-hanging fruit

4. Remove duplication/seek harmonisation

5. Ensure legal rules are predictable, proportional and consistent

6. Manage change (do it once and do it right)

7. Be wary of choice

8. Minimise grit in the system

9. Monitor complexity – don’t be afraid of (imperfect) metrics

And…..the 10th …..

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Tax reform

Class 15

Chris Evans


Tax reform: overview

This class addresses a number of issues:

• What is tax reform?

• What is successful tax reform?

• What sort of tax reform has gone on in OECD countries in the last few decades?

• What about tax reform in non-OECD countries?

• For reform to be successful, does it need to be underpinned or inspired by a government (or other body) review, commission or report?

• What sort of other factors enhance the prospects of successful tax reform?

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What is tax reform?

• Dictionaries give essentially two meanings of ‘reform’. One is to ‘improve’, ‘make better’, ‘remove imperfections’. The other is, literally, to ‘re-form’, to ‘restructure’, to ‘change’

• Politicians use the term in both senses—a restructuring which is also an improvement

• In this course, ‘reform’ is used in the second sense of restructuring or change without necessarily implying that the change is for the better

• Clearly not any and every change can be dignified by the designation ‘reform’. To justify that title, it needs to be a non-trivial change and to have as its objective something more than simply adding a little to government revenue or returning something to the taxpayer


What is tax reform?

Hence ‘tax reform’ could embrace:

• the introduction of a substantial new tax

• the abolition of a tax

• major changes in tax rates

• a change in the tax mix

• significant changes in tax administration (such as the introduction of a system of self-assessment, or the introduction of a new TIN system)

• a change in the tax unit, or

• the indexation of the tax system

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What is successful tax reform?

Sandford suggests, on the basis of analysis of tax reform in six common law countries, that there are three criteria by which successful tax reform might be judged:

1. the extent to which the tax reforms met the objectives the reformers set themselves;

2. the sustainability of the reforms; and

3. the extent to which the tax reforms had desirable or undesirable by-products.

(Source: Sandford C, Successful Tax Reform: Lessons from an Analysis of Tax Reform in Six Countries (Bath: Fiscal Publications, 1993), p 5.)


Trends in tax reform in OECD countries in last 20 years

• So what sorts of reform have been going on around the world in recent decades?

• What are the key trends?

Reading 15 (Kasalovska) Presentation: S Schmatz

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Trends in tax reform in OECD countries in last 20 years

• PIT/CIT: rate reducing/base broadening (BBLR model)

• General shift to greater reliance on general consumption taxes (BBCT)

• Profound and dramatic change in some tax systems (eg Australasia & E Europe)

• More gradual change in others (Europe, Asia)

• But all have substantially re-designed tax systems over time

• Trends in tax rates and burdens show many common themes (more similarities than differences)

• These similarities are reinforced by shared “drivers” of tax reform: desire to improve fiscal environment encouraging investment, risk taking, entrepreneurship; globalisation/capital mobility; tax competition; desire for fairness, simplicity, transparency


Trends in tax reform in non-OECD countries in last 20 years

• Many of the same trends as in OECD countries are apparent (eg BBLR, introduction of BBCTs, introduction of CGT regimes)

• Shift away from using the tax system to pursue other socio-economic goals (more pronounced than in OECD countries)

• Stronger trends toward

– simplified tax design (eg use of presumptive taxation)

– improved tax administration

• See, for example, O-H Fjeldstad and M Moore: “Tax Reform and State Building in a Globalised World” in D Bratigam, O-H Fjeldstad and M Moore Taxation and State Building in Developing Countries (Cambridge , 2008)

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Tax reviews: background• 3 major tax reviews in the last 10 years published within

12 months in 3 comparable countries (Australia, UK, NZ)

• Rare opportunity for comparative analysis

• NB dangers of comparison

• This session considers (in relation to these 3 reviews):

– Process

– Principles

– Outcomes

• Reveals certain similarities in approach and outcomes, but also considerable differences

• Identifies some factors that may make for successful tax reform


Background: Henry• Set up by Australian Government May 2008 after Summit

• Panel chaired by Secretary to Treasury, with two academics, one public servant and one business person

• Comprehensive root and branch review of Australia’s tax and transfer system (but not GST!)

• Aim is to “create a tax structure that will position Australia to deal with its social, economic and environmental challenges and enhance economic, social and environmental well-being”

• Reported on time in Dec 2009, but publicly released (with Government response) in May 2010

• 138 far-reaching recommendations (but RSPT inappropriately took centre stage)

• Followed by a Tax Forum in Oct 2011

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Background: Mirrlees• Set up by IFS in UK mid 2006

• Central team of 8 economists plus one lawyer, plus broader consultative group

• Aim was “to identify what makes a good tax system for an open economy in the 21st century, and to suggest how the UK tax system could be reformed to move in that direction”

• Followed in footsteps of Meade 1978, though broader remit (direct and indirect taxes, plus transfer system)

• First volume of report (Dimensions of Tax Design) released in 2010 (13 commissioned studies plus commentaries)

• Second (final) volume published in September 2011

• 18 major recommendations designed to remove existing major distortions and move towards a progressive neutral system


Background: TWG• Set up by VUW in conjunction with NZ Treasury and IRD in

May 2009

• Chaired by Professor Bob Buckle and comprised a mixture of academics, tax practitioners, business people and tax officials

• Aim was “identify concerns with the current taxation system; describe what a good tax system should be like; consider options for reform; and evaluate the pros and cons of these options ”

• Reported Jan 2010

• 13 major recommendations focused on rate reduction, alignment and some base broadening

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Comparing the processesSome similarities but rather more significant differences

Similarities– stated rationale

– public engagement and consultation

– length of output

Differences– accidental versus considered

– government controlled versus independent

– broad terms of reference

– perspective (time horizon)

– duration


Comparing the principlesNo significant differences

• Henry

– Equity (horizontal and vertical); efficiency; simplicity; sustainability; policy consistency

• Mirrlees

– “A progressive, neutral, system”

• TWG

– 6 principles related to overall system coherence; efficiency and growth; equity and fairness; revenue integrity; fiscal cost; compliance and administration cost

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Comparing the outcomesNo real convergence

• Henry

– 138 recommendations under 9 broad themes

• Mirrlees

– 18 recommendations broken down into 5 broad groupings (taxes on earnings; indirect taxes; environmental taxes; taxation of savings and wealth; business taxes)

• TWG

– 13 recommendations relating to direct and indirect tax rates and base, CT system, welfare policy and institutional framework


Comparing the outcomes (cont’d)

Little common ground

• All propose changes to base and rates

• But NZ far more immediate and limited: focus upon tax rate reduction and alignment with some broadening (but no CGT)

• Australia and UK greater focus upon structural issues and exploring new bases (eg wealth and land; congestion; resources)

• Australasia focus upon watching brief for CT system (imputation) cf UK with ACE proposals

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ImpactVariable thus far

• Henry

– 138 recommendations: 19 wholly or partially accepted by government; 24 wholly or partially rejected; 95 “pending” ie lost in the mists of time.

• Mirrlees

– 18 recommendations: 1 accepted (but may be down to OTS rather than Mirrlees)

• TWG

– 13 recommendations: 12 implemented, 1 pending


What value do independent reviews have?• It depends....

• Lessons from Mirrlees– Independence allied to a long term perspective can potentially set the

agenda for the future (Meade, Asprey, possibly Henry)

– But less immediate impact on policy making

• Lessons from TWG– Short term perspective can have immediate impact

– Particularly when allied with government support

• Lessons from Henry– If you start open, stay open

• Final takeaway– Reviews are useful on a periodic basis, especially for public

engagement (but don’t necessarily assume you’ll get a more informed public debate)

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What makes for successful tax reform?

Reading 16 (Brys) Presentation: W Hermans


What makes for successful tax reform?

• Factors that enhance prospects of success:

– the existence of a “vision”

– sound economic principles

– the political dimension

– a political champion

– constitutional and other factors

– a package of reforms

– an appetite for reform

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Documents

Taxation of Capital Gains - international-tax-law.at · income (income is the increase in a person s wealth over two points of time) Hence does not matter whether income is revenue