This article outlines the importance of tax revenue to governments, the changes in legislation to secure this revenue and the impact on business practices.
Author: Victor Kimang’a – LL.M. Candidate at IE Law School’s Master in Global Taxation
Irrefutably, the prominence and relevance of tax revenue to governments across the globe is at an all time high. The demands of development and progress of the economy have put immense pressure on governments to perform. This has been compounded by the increase in ageing populations particularly in developed countries and the challenges in sustaining social welfare regimes. Consequently, the default fall back has been modifying fiscal policies, chief among these are tax policies, to quench the thirst from different sectors of the economy.
The pressure on governments has been compounded by increasingly well-informed members of the public and various advocacy groups. Additionally, evolving business practices have led to governments losing tax revenue. This is due to proliferation of innovative tax structures particularly by big multinational enterprises that has led to revenue leakages. Various initiatives have been formulated to tackle these challenges, spearheading the revolution has been the BEPS project by the OECD.
We need to reflect on the events leading to this situation. Innovative tax structures have been in place for decades but have been under intense scrutiny lately. Some of the key factors are; different tax laws across different jurisdictions which allow varying treatment and interpretation of similar transactions, exploitation of tax treaties. Arguably, this may have been facilitated by intense competition to attract investments amongst countries.
However, it is important to note that the focus here is on briefcase structures aimed at misrepresenting revenue rather than legitimate tax competition by countries for real capital. Further, an emphasis by companies to ensure tax savings by all means has accentuated the use of innovative tax structures. Ultimately, some countries have achieved high tax revenue to the detriment of other countries.
Evidently, the trust that existed between governments and taxpayers has been significantly impaired. The question is, what can be done to remedy the situation and rebuild the trust.
How have Governments responded?
Governments have reacted by implementing policies and fronting proposals that effectively seal legal loopholes. Increasingly, this is becoming a collective effort by many countries doing this simultaneously, for instance by signing agreements. Due to the broken trust, governments now favor a hard-nosed approach that may not be practicable in the present rapid changing business environment.
There is a cocktail of new laws covering many areas but focused on ensuring minimization of tax avoidance strategies and improper use of tax planning mechanisms. These changes are aimed at correcting erosion of tax base and checking the tax structures employed by companies.
What has the impact been?
The major impact has been the strained relationship between governments and taxpayers. There are mixed feelings with regard to the effectiveness of constantly changing or introducing tax legislation. Currently, companies particularly multinationals that operate in many countries are required to comply with many tax regulations across the different jurisdictions.
Compliance with taxes has become a strenuous and painful exercise which is contrary to the fundamental principles of taxation. This has significantly increased the cost of doing business and may lead to companies shutting down. This will negatively impact the tax revenue collected conflicting with governments’ objective to increase tax revenue.
Further, the rapid modification and introduction of tax legislation has led to a lack of certainty when conducting business. Consequently, it has become increasingly difficult to plan for businesses. Ultimately, the innocent victims of this uncertainty are end consumers who have to bear the increasing cost of goods and services.
What is the way forward?
Unfortunately, there is no end in sight unless a few steps are taken. In my opinion, these steps should include the following;
- Mending the relationship between taxpayers and government – this will ensure that there is a move from confrontation to coordination. Both sides need to agree on basic underlying concepts before new tax laws are drawn.
- Reduction of complexity in tax legislation – governments should work to ensure that tax laws are easy to comply with. This will encourage compliance and increase tax revenues. Additionally, governments should desist from using mechanical, uncompromising approaches to interpreting legislation.
- Robust multilateral tax laws – A possible solution may be to harmonize tax laws across jurisdictions to ensure there is uniformity of laws. This can be complemented by enhanced information sharing and coordination amongst different countries. This may necessitate the need, for instance of an overhaul of corporate tax systems to adopt a new platform that is simpler and less burdensome.
- Digital economy impact – increasingly businesses are adopting digital platforms. On the other hand, tax administrations have not evolved fast enough to accommodate the growing digital economy. There is a pressing need for the tax authorities to appropriately adopt the tax laws otherwise risk losing the revenue collection battle.
Further to the above, to ensure sustainable growth and development, businesses have to align their operations with the relevant tax regulations and fulfill compliance requirements. This is a delicate task but is necessary to ensure they stay afloat in the compliance pool.
Victor Kimang’a is currently an LLM Candidate at IE Law School in Madrid. He has prior experience having worked at PricewaterhouseCoopers Kenya Indirect Taxes Department.
Note: The views expressed by the author of this paper are completely personal and do not represent the position of any affiliated institution.