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Tax and accounting

Tax scrutiny hits energy and manufacturing multinationals hard

Published on by Joe Harpaz

Tax rules and regulations can wreak significant financial havoc on corporations in today's day and age.

Take for example the instance when the U.S. Treasury finalized anti-tax inversion rules that contributed to the demise of Pfizer’s $160 billion acquisition of Allergan (based in Ireland). Similarly, the instance when the European Commission ruled against Apple, suggesting Ireland granted the company undue tax benefits of up to $14.5 billion for sales recorded in that country which should have been attributed to other markets.

These examples underscore the need for large multinationals to pay close attention to corporate tax requirements, despite news in the West that might imply a more lenient environment such as under U.S. President Trump’s tax reform plan.

Another example is the Federal Court of Australia’s unanimous decision against Chevron, which resulted in a fine of AUD $340 million in unpaid taxes. This case highlights the perils that can ensue related to transfer pricing, when foreign subsidiaries of a multinational corporation transact business with another unit at a given price and then pay taxes on that activity in the country where the profit was realized.

In this particular situation, Chevron issued a US $2.5 billion loan to its Australian subsidiary to fund development of gas reserves in Western Australia. The challenge arose when investigators found that the US entity was borrowing funds at a rate of 1.2% and then lending them to the Australian entity at an interest rate of roughly 9%. This tax structure had the effect of reducing Chevron’s Australian taxable income by allowing the company to pay interest payments as tax deductions.

On the surface, this may seem like a relatively minor technicality. A tax bill of AUD $340 million for a company with 2016 revenue of US $114.5 billion and a market cap of US $200.9 billion isn’t likely to create shock waves for the company, but it is noteworthy because it’s just the beginning for the Australian Tax Office as it starts proactively pursuing such accounting irregularities.

In fact, an analysis commissioned by The Conversation, an independent investigative news organization in Melbourne, found that if Australia cracked down unilaterally on all similar inter-company lending structures being used by other companies in the energy industry, the country would realize several billion dollars in additional tax revenue.

For its part, the Australian Tax Office has indicated that similar cases are in the works, telling the Financial Times that this energy instance “has direct implications it is currently pursuing in relation to third-party loans, as well as indirect implications for other transfer pricing cases.”

For some perspective on just how big an issue this could become, the Australian Tax Office estimates that roughly 2,600 companies claimed AUD $14.5 billion in interest deductions on AUD $420 billion worth of loans from foreign entities between 2014 and 2015.

It’s not just in Australia either. The big raid by federal agents on Caterpillar headquarters in Illinois this past March traces its roots to a Swiss subsidiary. It was part of an investigation launched in 2014, which alleged that Caterpillar allocated more than $8 billion in non-U.S. profits on replacement parts to its Swiss subsidiary over 13 years, ultimately deferring $2.4 billion in U.S. taxes on those profits. Caterpillar contested the findings, but it is clear that federal investigators think there’s still more to uncover here.

These cases are so important because they underscore just how big of an emphasis tax authorities around the world are still placing on rooting out overly aggressive corporate tax strategies, even if those stories have faded from the front page.

The Trump administration’s tax plan would certainly go a long way toward addressing some of these issues since it would put the U.S. corporate tax rate on a more even footing with those in the rest of the world.  That would take away much of the incentive to shift profits into lower tax regimes.  But, there are still many miles to go before that plan will be implemented and it wouldn’t necessarily address the issue of inter-company lending that’s at the heart of the Australian issue.

Multinationals operating in the current environment need to recognize that – beyond the Trump headlines – we’re all operating in a post-BEPS world where global tax authorities have near complete transparency into the domestic and foreign profits and taxes paid by companies in nearly every jurisdiction in which they operate. As they get increasingly adept at analyzing that data and building legal cases based on it, there will be serious consequences for companies that cannot provide a plausible tax story to support their strategies.

This article is repurposed in part for a story that originally ran on Forbes.com

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