The global financial crisis had a significant influence on the present tax framework – so how might the battering now being taken by state finances manifest itself in tax policy?
As the UK’s chancellor of the exchequer, Rishi Sunak, stood up in the early days of November to announce an extension of the furlough scheme until the end of Q1 2021, in common with many concerned about the wider economic ravages being caused directly or indirectly by covid-19, I breathed a sigh of relief. Bluntly put, the impacts on a significant number of families the length and breadth of Britain with subsequent multiplied economic impacts could have been catastrophic, had the scheme not been extended.
The extra breathing space, beyond the second England-wide lockdown and similar measures in Wales and Scotland, will be a big relief for both individuals and a large number of small and medium-sized businesses as the support from the government is continued. It appears to be clear that, absent a widely distributed functioning vaccine, society may be dipping in and out of lockdowns for some time to come, with the chancellor presumably intending to provide similar support should that happen.
Beyond the initial, and wholly supportive, reaction, as a tax professional whose memory stretches back beyond 2008, the mind begins to wander and consider what fiscal policy has in store for us over the coming years.
The direct impact of the GFC from a tax perspective has taken around a decade to be largely implemented
The impact of the 2008 global financial crisis (GFC) that started as a private sector financial problem and developed into a national and international sovereign crisis, where even the financial viability of developed nation states was put at risk, had some startling impacts from a fiscal and monetary policy perspective. We are now over a decade into an era where interest rates have not at any time exceeded 2.25% in the EU, the US or the UK. In the UK the policy of austerity was pursued for a number of years post-crisis to deal with unprecedented government spending to prevent the feared financial apocalypse. Austerity has been a hugely controversial policy, however it is defined, with impacts, costs and benefits highly dependant on your political perspective.
Short-term tax policy post-GFC saw a number of temporary ‘solidarity’ surcharges as well as temporary sales tax increases in a number of jurisdictions (confusingly also alongside consumption tax decreases to stimulate spending). The impact on longer-term tax policy has been similarly, but perhaps less obviously, revolutionary and has led to remarkable changes and expansion of the tax base and data-gathering tools of tax authorities worldwide. While tax has had international aspects for many years, with varying degrees of coordination, a truly concerted internationally coordinated approach really only became apparent post the GFC.
At the G20 in 2012 the conference requested the OECD to propose initiatives to tackle the problem, widely perceived, that internationally mobile capital and ‘big business’ was not contributing its ‘fair share’ to national exchequers. This resulted in the Base Erosion and Profit Shifting project. The OECD came through with 15 initiatives by 2015 which aimed to increase transparency with respect to international structures, limit the amount of tax deductions within groups of interest and other charges to the ‘arm’s length position’ as well as challenging structures that sought to roll up profits in low or no-tax jurisdictions.
While the BEPS ‘15 Actions’ were published in 2015, we are still seeing the legislation being introduced across many jurisdictions to implement the recommendations or variations thereof. We have seen some countries act unilaterally as well as the development of related trans-national initiatives introduced by the EU among others. The direct impact of the financial crisis from a tax perspective has therefore taken around a decade to be largely implemented and the full consequences remain to be seen. In truth, many tax authorities don’t have the IT or human resource capacity to analyse all the data they now receive. Interestingly, the introduction of many of the initiatives to reduce the ability to erode the tax base has coincided with a general reduction in mainstream corporate tax rates across the OECD members. The message to international taxpayers seems to be ‘don’t try to structure around the tax base, but as a quid pro quo we’ll take a smaller slice’.
So, will property escape a battering this time? Unfortunately, it is unlikely
The international property investment industry was not the main target of the BEPS initiatives; property is inherently immovable, tangible and consequently is well understood to be primarily taxable in the jurisdiction where it is located. However, notable suspicion from the public, commentators and legislators is now inextricably linked to the phrase ‘owned by an offshore company’ when considering property. As a consequence, typical cross-border property investment structures have ended up in the crosshairs of a number of the initiatives.
Emboldened by OECD findings, individual governments have also begun to modernise the approach to taxing international structures rather than relying on the well-established but arguably unfit for purpose framework which did not anticipate the feasibility of daytrips for board meetings overseas (and even less the concept of the internet and how a business could possibly serve the world from a bank of servers located in an obscure data centre).
The well-trodden path of using intercompany debt financing to fund a single (or indeed multi-) property special purpose vehicle is now subject to a bewildering array of interest limitation rules, mandated transparency over how the structure is established, numerous documentation requirements with respect to how it is owned, run and financed and the implied need to support the ‘substance’ of the ownership entities in a given jurisdiction. Many of these measures were indeed sensible in a number of contexts – yet property, which was never the prime target, is dragged in owing to the blunderbuss approach to international tax policy.
So, given the link between the global financial crisis and the development of the present tax framework, how might the battering now being taken by state finances manifest itself in tax policy?
The BEPS initiatives were driven partly by public clamour for action against perceived unfair tax avoidance and a very real need for government revenues. The clear target at that time was the financial services industry, having required multi-billion government bailouts. Although the financial services industry appears to be resilient and well-capitalised this time round and thus not immediately the user of government funds and is perhaps not the obvious target for that reason, it may yet be the target for precisely the reason that it has proven to be more resilient and therefore ripe for bearing additional costs.
It appears unlikely that the government will seek to target the SME sector and struggling families as they emerge from challenges of covid for the longer-term funding, though we may see a general upward trend to income tax rates. Recent reports in the UK have recommended both an increase in capital gains tax rates and consideration of wealth taxes (which typically are driven by land holdings to a large extent).
Clearly taxation may have to rise. We may see consumption taxes (such as VAT and sales taxes) rise by a small margin, though governments may be reluctant to further depress consumer spending. The clear winners during covid have been the tech companies; notably e-retailing has seen unprecedented levels of activity during the coronavirus pandemic and associated lockdowns. The BEPS initiative has been partly successful in seeking to modernise the tax system to raise revenues from these new business models, but the sense lingers that it has not fully accessed the ‘fair share’ that politicians seek to raise. Conventionally, tax has focused on taxing people and companies by virtue of where they carry on their business; this will continue to shift to tax based on the location of customers. So, will property escape a battering this time?
Unfortunately, it is unlikely. The typical real estate investment structure established by a collective investment fund has a remarkable number of features that may get caught where initiatives are taken to target a ‘tech’ structure. If we read across the concept that is gaining popular ground of seeking to tax a taxpayer based on the location of its customers rather than on the presence of the business it may cause a number of fund managers to pause to consider the meaning of ‘customers’ – this couldn’t catch the investors of a widely held fund, could it? While recent developments in the OECD’s latest thinking gives some cause for optimism with respect to fund structures, this is by no means guaranteed to be adopted by national legislators.
The long-term impacts of the pandemic will only really become clear as we start to see how the recovery looks, but it is clear that there will be significant need for governments to repair their national finances and tax policy will almost inevitably be part of that solution. The timing of BEPS 2.0 will certainly seek to address some of the perceived failings of BEPS 1.0 and it is likely that the overall tax burden is going to go up.
