Martin Lock was formerly the top withholding-tax specialist at the Tax Office, a role that encompassed oversight of profit shifting by multinationals.
He is one of many former officers who have voiced their concerns to Fairfax Media about the challenge of arresting the slide in tax receipts from multinational companies operating in Australia.
Like many of his colleagues, Lock took a voluntary redundancy in June this year. During the past three years, the number of those at the Australian Taxation Office supervising international activities has been gutted, with staffing levels about a quarter of what they were. That at a time when the scourge of tax avoidance, particularly by United States tech giants, has been more pronounced than ever.
Ongoing tax secrecy laws prevent former tax officers commenting on specific company tax affairs. All of Lock’s observations are based on information in the public domain.
He pulls no punches describing the profound problems of large-scale tax avoidance, describing the Australian Tax Office as politicised under the spell of Treasury and unaccountable to the public.
Its top bureaucrats are reluctant, he says, to prosecute large companies and the Big Four global tax advisory firms, PricewaterhouseCoopers, KPMG, Deloitte and Ernst & Young – as evidenced by PwC’s role in the recent LuxLeaks scandal – are intimately involved in facilitating tax avoidance.
What emerges is a picture of an agency that has become compromised by powerful vested interests, although it continues to pursue small taxpayers with vigour.
Profit shifting has become a monumental problem, not just for Australia but for all developed countries with relatively high corporate tax rates. Despite this, the Australian Tax Office, though required by legislation to act independently, is yet to report the scale of the problem to parliament through the Commissioner’s annual reports, says Lock.
Instead, it has been politicised, he says, and is acting as an agent of Treasury while the parliament and the public are kept in the dark.
“Innumerable references, both in its annual reports and on its website to ‘working with Treasury’, and … parroting Treasurer Joe Hockey’s words, belie an unapologetically politicised ATO,” Lock says.
“Responding to the recent Luxembourg revelations concerning corporate tax avoidance and PwC’s complicity in it, [the ATO] uses the politically charged and hackneyed terms ‘aggressive tax planning’ and ‘unfair tax competition’ as if they had any meaning or consequence under Australia’s tax laws.”
Under the law, they don’t.
Moreover, aggressiveness and unfairness in tax avoidance are not yardsticks of tax liability; what is relevant is whether the ATO can prove that a multinational’s tax schemes do not carry the tax consequences the multinational claims.
“And that’s the nub of the problem, a problem the ATO speaks little about, in particular to parliament to whom it is ultimately answerable.”
To achieve “tax effective outcomes” and remain “tax competitive”, multinationals usually engage the services of the global tax advisory firms KPMG, PwC, Deloitte and Ernst & Young, to tailor “tax planning solutions” (concoct tax avoidance schemes, that is).
“Almost effortlessly, a new subsidiary, partnership or trust can be established in any favourable tax jurisdiction, including in a tax-treaty country (‘treaty shopping’),” says the man whose role encompassed the purview of tax treaties and base-profit erosion.
With little more than book entries, the multinational can then convert billions in equity into billions in “loans” from a related-party, or sell its intellectual property to the related party and license it back, dramatically altering the multinational group’s prospective tax bill.
“If need be,” Lock says, “the multinational can even shift a parent company or subsidiary’s tax residency by doing little more than flying the board members to a chosen tax-treaty country and holding a tax-deductible annual board meeting there.”
In the wake of revelations in these pages of multinationals taking out massive loans from related parties at high interest rates, the government recently announced measures to strengthen the “Thin Capitalisation Rules”.
These stipulate the level at which tax deductions can no longer be claimed on debts from related foreign parties (many multinationals have far higher gearing here than in lower tax jurisdictions as it can effectively lower their profits, on which tax is paid, and merely shifts money offshore.)
No sooner was the ink dry on these new provisions that the advisory firms were plotting how their clients could get around them.
Now the multinational can ditch the “safe harbour test” – which is not so safe any more – in favour of the “arm’s-length debt test”, Lock says, “or better still, the “worldwide gearing test”, a fact not lost on KPMG, which issued a recent paper on the subject advising clients how to skirt around the new provisions.
“The advantage of the latter two tests is that either one can tie up the ATO for years, with the disputing sides arguing over endless ‘length-of-a-piece-of-string’ questions loathed by the courts, debating for instance the market values of intangible assets such as intellectual property and mining rights ‘where expert minds may reasonably differ’.”
Then there is the application of judgment-based and “depends-on-the-facts” accounting principles; the amount imaginary lenders would lend the corporate assuming it ran an imaginary business that excluded certain assets, liabilities and foreign branches; how the lender would view the state of the Australian economy; and the weight the lender would attach to imaginary credit support provided by related companies.
“Disturbingly, these ‘Alice in Wonderland’ concepts are central to the Thin Cap legislation, legislation designed with the assistance of corporate tax industry ‘stakeholders’, legislation the ATO ostensibly administers.
Advance Pricing Agreements (APAs), now under threat following the Luxembourg expose by the International Consortium of Investigative Journalists, formalise uncertainty of the law if not tax avoidance, Lock says.
“APAs in fact get no mention in the tax law. Instead, they are the ATO’s concession to the stark reality that the transfer pricing rules, like so many other international tax rules, are so vague, uncertain and cumbersome, or open to manipulation, that they’re practically unadministrable,” he says.
“It is therefore easier for the ATO to simply cop out and strike whatever agreement it can with multinationals over the pricing of related-party transactions than take disputes to courts that see no judicial value in resolving them. The result is taxation by negotiation not legislation.”
This is clearly not the experience of smaller taxpayers.
The ATO’s response to the Luxembourg tax avoidance revelations – which arose, as is usual with these things, not from the beefed-up “risk management strategies” of the Tax Office but from leaked documents – is that Australian participants in the APA schemes who, in Konza’s words, “misled” the ATO will have their APAs revoked.
Is that all, asks Lock? “Deliberately or recklessly misleading the ATO is a criminal offence, punishable under sections 8K, 8N and 8R of the Taxation Administration Act 1953 by fines for the company, and fines or imprisonment for the company officer who authorised or made the misleading statement.
“Six APAs have recently been revoked. Konza should therefore be asked whether he has referred the relevant APA participants to the Director of Public Prosecutions for prosecution.”
The ATO’s track record of prosecution, he says, is remarkable for its lack of corporate scalps: “It hasn’t prosecuted a large public company, or an officer of one, in living memory.” Compare this to the efforts of the US Internal Revenue Service. Lock cites a number of big-ticket prosecutions.
Back in 2005, the US Justice Department won a landmark tax-shelter case when accounting giant KPMG admitted criminal tax fraud and agreed to pay $456 million in penalties. Eight former KPMG partners were indicted with one or two jailed, as well as an outside lawyer.
The Internal Revenue Service alleged that KPMG, its eight former partners and the outside lawyer conspired to mislead the IRS by lying about the details of tax shelters, some of which involved deals done through the Cayman Islands.
In 2002, accounting firm PricewaterhouseCoopers agreed to make “a substantial payment” to the IRS as settlement for marketing corporate tax shelters and failing to comply with rules requiring it to keep a list of such shelters and the clients who used them.
More recently, Ernst & Young agreed to pay $123 million to resolve a US tax-fraud investigation. As part of a non-prosecution agreement, the partnership “admitted wrongful conduct” by its partners in connection with four tax shelters designed to avoid billions of dollars in tax from 1999 to 2004.
In Australia, however, the ATO favours what Commissioner Chris Jordan calls the “light touch” approach, working in collaboration with business stakeholders.
The ATO’s most recently reported response to multinational tax avoidance has been to hold a closed-door conference hosted by Clayton Utz and the Business Council of Australia, where business and tax officials gathered to discuss the OECD and G20 fight against base erosion and profit shifting.
“There was no indication the Australian Federal Police fraud squad was invited to participate, that any minutes of the meeting were kept or that parliament would be informed of the outcome,” Lock says.
When former commissioner Michael D’Ascenzo was asked at a 2012 Joint Parliamentary Committee hearing whether he had considered disclosing to any extent the Tax Office’s secret communications with Treasury, his response was to defer the question to Treasury.
From his response it might be construed that the Commissioner has a legal obligation to take his directions from the Treasurer and/or confer with, or seek advice from, the Treasurer concerning tax law interpretation and other matters. This is not the case, however.
“Contrary to impressions the ATO creates, the extent of the Commissioner’s legal obligations to the Treasurer is simply to hand him the Commissioner’s Annual Report 15 days before the Treasurer tables it in Parliament. That’s all.”
Lock cites the Tax Office website as proof of its lack of independence and the encroaching politicisation of the agency.
The Treasury and the ATO are committed to working collaboratively and continuously to provide the best possible advice to Government on issues affecting the [tax and superannuation] systems, and the implementation of Government policy to meet the needs of the community who are the users of these systems.
… The ATO is the Government’s principal revenue collection agency, and part of the Treasurer’s portfolio.
… In forming its view on the interpretation of law, the ATO will routinely consult senior members of Treasury’s Law Design Practice and the professions, and undertake community consultation and release draft views for public comment in accordance with its long-standing practices.
The ATO will engage the Treasury on policy and law design issues that are identified in the administration of the law at the earliest possible juncture. In particular, where the ATO identifies that enacted law is not operating consistently with what is understood to be the policy intent of the law, the ATO will provide advice to Treasury recommending law change to ensure that the policy intent is met.
Parliament itself doesn’t rate a mention. Just Treasury. The government therefore is in the picture when it comes to avoidance yet both main political parties also receive political donations from the major multinational tax avoiders, which the ATO is supposed to police.
Further, says Lock, as Mark Robertson QC points out in The dangers of the ATO’s “policy intent” approach to the construction of Tax Acts, the ATO’s search for the underlying “policy intent” when interpreting tax legislation “presents an insidious danger to the rule of law”.
As the High Court has repeatedly said, the “intent” of a legislative provision is to be found in the words of the statute itself. As Justice Murray Gleeson said, “the process is one of elucidating the meaning of a text, not psychoanalysing some person who played a part in formulating the text”.
“Not until the ATO reasserts its independence will parliament and the public find out what the ATO really knows or doesn’t about the scale of multinational tax avoidance in Australia,” Lock says.