Who’s Who Legal brings together Michael Schler ofCravath Swaine & Moore, Michael Honiball ofWebber Wentzel, Jennifer Fuller of Fenwick & West and Jean-Blaise Eckert of Lenz & Staehelin to discuss the impact of increasing inter state collaboration on tax avoidance, competition from accountacy firms, and the continued emphasis of governments on tax disclosure and transparency on their practices.
Cravath Swaine & Moore LLP,
Johannesburg Jennifer Fuller,
Fenwick & West LLP,
California Jean-Blaise Eckert,
Lenz & Staehelin,
WWL: Political and media attention surrounding the base erosion and profit-shifting (BEPS) project of the OECD continues to rise. What work has this generated for lawyers?
Michael Schler: Draft proposals for some of the BEPS projects have been released, and other drafts will not be released until next year. Even for the drafts already released, there are likely to be significant changes before definitive proposals are released later this year or next year. Even then, different countries may adopt different forms of the proposals. As a result, it is now too early to engage in transactional planning to take account of any specific BEPS proposal. However, new structures being created today (such as hybrid instrument or hybrid entity arrangements) must take account of the possible effects of future BEPS legislation, and it is never too soon to begin evaluating existing structures in light of possible future legislation. In any event, it is by no means clear whether and to what extent the US will adopt any final BEPS proposals, although US multinationals will obviously need to keep track of legislation adopted in each jurisdiction in which they do business.
Michael Honiball: The BEPS debate has created a greater awareness by corporate taxpayers about existing transfer pricing and the permanent establishment rules but has not yet directly led to an increase in tax advisory work. However, recent South African legislative amendments have already considered and addressed many BEPS issues. For example, new rules have been introduced about hybrid debt, transfer pricing and acquisition debt. These changes have directly led to an increase in advisory work around these topics.
Up to now, the South African Revenue Service (SARS) has aggressively targeted South African (outbound) multinationals, as opposed to foreign (inbound) multinationals, presumably because they are an “easier” target. However, more recently, possibly due to the BEPS initiative, they have been targeting the permanent establishments of foreign corporations, and foreign multinationals generally, and this has led to an increase in advisory work.
Jennifer Fuller: It is difficult to comment at this point about work BEPS has generated for lawyers. The tax community does not yet know what BEPS will mean. The US government is seriously concerned about BEPS dragging profits out of the US, which could happen if foreign countries assert that more profits should be taxed within their borders in reliance on BEPS principles. US companies might have to allocate more income to those countries, and away from the US. US companies also could have substantially increased foreign tax credits.
US Senator Orrin Hatch even raised this point in hearings last week, which were attended by Pascal Saint-Amans (director of the OECD’s Centre for Tax Policy and Administration) and Robert Stack (a US Treasury official). Bob Stack expressed his concern about “winners” and “losers” regarding the digital economy discussion draft. He was concerned about the US as a “loser” and said that reaching a multilateral agreement in such a case might not be possible.
Another problem is that some countries might adopt BEPS principles in legislation and some might not – the US could get stuck in the middle.
In regard to the digital economy discussion draft, it’s worth noting that the Obama’s 2015 budget proposes to make digital economy income of US parent companies subpart F income: taxable here. This is seemingly contrary, in principle, to the BEPS discussion draft’s “virtual PE” idea.
Jean-Blaise Eckert: The BEPS debate has a special importance in Switzerland because of the planned legislative changes (Corporate Tax Reform III). As an OECD member, Switzerland is committed to the BEPS objective, while particularly emphasising that the standard should be based on reciprocity. Regarding the kind of work it will generate, as Switzerland is an important economic centre and hosts many multinational enterprises, it will be focused on complying with BEPS standards. Therefore, structures being created today, as well as structures being reviewed, must take into account the possible impact of the BEPS project. This has led to an increase in advisory work around this topic.
WWL: Inter-state collaboration to counter tax avoidance is becoming increasingly common, with information being “traded” between territories. How has this affected your practice? Are you advising on more cross-border matters than before? Is it increasingly important to have a network or strong relationships with lawyers in different jurisdictions?
Michael Schler: Cross-border transactions have become increasingly important over the years, totally aside from inter-state attempts to stop tax avoidance. For these transactions, it has always been critical to have strong relationships with lawyers in different jurisdictions. For business transactions between unrelated parties, inter-state efforts to stop tax avoidance should have little or no adverse effect, if taxing jurisdictions respect normal arm’s-length transactions. Inter-state collaboration is likely to have more of an effect on transactions among affiliated entities, and increasing care must be taken to be sure that the positions adopted in each jurisdiction are consistent and defensible.
Michael Honiball: Inter-state collaboration involving South Africa has substantially increased in the Past three years. Many tax treaties have been amended to allow for the inclusion of article 26 of the OECD MTC or equivalent, for example the tax treaties with the UK and Australia. This article (or its equivalent) has been used by SARS in respect of high net worth individuals (reported cases include that of Dave King (see the UK case of HMRC and Anor v Ben Nevis and Anor  EWHC 1807 (Ch)) and Mark Krok (see the South African High Court case of C SARS v Mark Krok and Anor  2 ALL SA 66 (GNP)) and also in respect of multinational corporations (no reported cases yet but several rumoured to be in the pipeline, including one large transfer pricing case). Therefore, interstate collaboration has clearly brought in more work for tax lawyers. It is further anticipated that there will be a number of high net worth individuals who will come forward and make use of the voluntary disclosure programme (VDP) going forward as the inter-state collaboration (including information sharing) becomes more active.
There is a question about whether or not SARS will have the manpower and expertise to give effect to, or make good use of, the relevant tax treaty collaboration and exchange of information provisions. Most of South Africa’s tax treaties provide adequately for exchange of information. South Africa has also signed tax information exchange agreements (TIEAs) with numerous tax havens. The mere fact of signing these TIEAs has directly led to more work involving both high net worth individuals and corporates.
Following on from this, clients are increasingly favouring law firms that have a network or a strong relationship with lawyers in different jurisdictions. Webber Wentzel’s alliance with Linklaters globally, as well as our continued association with ALN for Africa, has been successfully used to defend clients who are on the receiving end of SARS queries and assessments which arise from inter-state collaboration.
Jennifer Fuller: Our practice involves a lot of cross-border transactions. We operate in a global economy that results in a very large portion of our advice focusing on cross-border matters. It is very important to work with good foreign tax counsel.
Jean-Blaise Eckert: Inter-state collaboration involving Switzerland has substantially increased in the past five years, since 2009 when the Federal Council decided to extend administrative assistance and adopt the standard set out in article 26 of the OECD MC. Group requests have also been permitted since March 2013. Consequently, many treaties have been amended to allow for the inclusion of article 26 of the OECD MC or equivalent. This article has been used by foreign tax authorities (in particular France) to obtain banking information related to individuals. It is also increasingly used in relation to multinational corporations (transfer pricing cases). Regarding the tax dispute between Swiss banks and the US, both countries signed a joint agreement which puts an end to the 2013 dispute and defines a framework for cooperation with the US authorities. Switzerland has also signed TIEAs with numerous tax havens, even though few are yet in force. Moreover, the automatic exchange of information in tax matters with partner states should be confirmed in September 2014. Thus, inter-state collaboration has brought in additional work for tax lawyers regarding these topics. As a result, clients are increasingly favouring law firms with an international expertise or strong relationships with lawyers in different jurisdictions.
WWL: There is a move among the big four accounting firms to increase their legal activities, as exemplified by PwC gaining ABS status in the Middle East and the UK earlier this year. With other firms possibly following suit, how do you expect this to impact competition in the corporate tax legal sector?
Michael Schler: In the US tax context, there is no significance to the big four accounting firms moving into the legal area. All the big four firms already have extensive US tax practices in which they give tax advice on corporate transactions. They have built up excellent tax departments, and we frequently work with them both on our side and on the opposing side of transactions. I do not expect this to change regardless of whether their firms engage in legal practice, although that seems very unlikely to happen in the US.
Michael Honiball: South Africa does not yet have a law-firm model like the UK’s ABS model. In South Africa, tax dispute resolution, especially in its advanced stages, is mainly the domain of attorneys and advocates. We do not expect to see accounting firms engaging in tax litigation in the short to medium term. Further, the question of legal professional privilege within the accounting firm environment is still not settled. There is, therefore, a fundamental benefit that the big four accounting firms may not be able to fully provide to their clients, and that is legal privilege. Further, in South Africa, registered accountants have additional reporting obligations in respect of tax contraventions which attorneys and advocates do not have.
Jennifer Fuller: Any increase in legal activities by the big four accounting firms has had no impact on our practice. In fact, we often work on issues with them. They have good tax people, too.
Jean-Blaise Eckert: Switzerland does not have a special status similar to the ABS model. In Switzerland, although those kinds of accounting firms can represent clients in tax proceedings as there is no formal monopoly of lawyers in tax law, tax dispute resolution, especially before high courts, is mainly the domain of law firms. Considering the specificity of the procedural rules before the Swiss Federal Supreme Court in particular, it is advisable to use the services of lawyers. Moreover, non-lawyers can neither benefit from legal privilege nor invoke it before courts. A global move of the accounting firms in the direction of tax litigation might, however, result in more and more aggressive planning and competition in general.
WWL: Efforts to increase tax disclosure and transparency continue throughout the world with the US firmly at the forefront. Has this created additional work for your practice?
Michael Schler: In the US, disclosure on a tax return is required in many cases to avoid the risk of tax penalties, or to reduce the potential size of tax penalties. For example, a violation of the statutory economic substance doctrine gives rise to a mandatory penalty of 40 per cent of the tax due, unless disclosure is made in which case the mandatory penalty is 20 per cent. Because of the vagueness of the doctrine, there is an incentive to disclose transactions in order to avoid the risk of the 40 per cent penalty, even if violation of the economic substance doctrine is not considered likely. Additional work arises from the need to evaluate the likelihood that a transaction will give rise to mandatory or discretionary penalties, and the potential benefits of disclosure.
As an entirely separate matter, FATCA has added a large amount of work in advising US issuers, as well as US and non-US financial institutions and nonfinancial businesses, as to their obligations under FATCA. Even in relatively simple fact patterns, the questions can be very difficult. As worldwide information reporting becomes more prevalent, the amount of work will certainly increase.
Michael Honiball: FATCA and similar initiatives have led to an increase in tax advice to high net wealth individuals, especially in relation to offshore trusts. It is anticipated that as awareness increases and the effects of these and similar provisions in fact materialise, we will see a lot more clients seeking advice, applying for VDP, and seeking assistance in SARS-related litigation.
Jennifer Fuller: The US government and others in the tax community are very concerned that country-by-country (CbC) reporting will lead to formulary apportionment and away from the arm’s-length standard. The question is how different countries are going to use transparency concepts.
If the world moves in the direction of formulary apportionment, and away from the arm’s-length standard, BEPS could well be remembered as producing a disservice to the international community. Formulary apportionment doesn’t eliminate planning; it only changes the planning. It could create winners and losers as countries (like US states) compete with each other for jobs, revenue, etc.
Even if it does not lead in that direction, many companies, and the US government, are concerned about potentially misguided use of CbC data that could result from various countries trying to use or interpret the new data. The Tax Executives Institute submitted lengthy, written comments on this point, and Bob Stack has also expressed serious concerns.
Jean-Blaise Eckert: In Switzerland, FATCA in particular has led to additional work, especially regarding tax compliance advice. As Switzerland is an important financial centre, specifically in the domain of asset management, FATCA directly created additional work regarding the process of auditing FFIs in order to report US persons holding accounts in these institutions. In Switzerland, FATCA implementation is based on Model 2 and the agreement came into force on 2 June 2014. A new agreement based on Model 1 providing for the automatic exchange of information should be adopted, but the date is not yet defined.