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FOUNDATIONS FOR A SOUND TAX SYSTEM: SIMPLICITY, CERTAINTY AND STABILITY 2020 Association of Chartered Certified Accountants September 2020 About ACCA ACCA is the Association of Chartered Certified Accountants. Were a thriving global community of 227,000 members and 544,000 future members based in 176 countries that upholds the highest professional and ethical values. We believe that accountancy is a cornerstone profession of society that supports both public and private sectors. Thats why were committed to the development of a strong global accountancy profession and the many benefits that this brings to society and individuals. Since 1904 being a force for public good has been embedded in our purpose. And because were a not-for-profit organisation, we build a sustainable global profession by re-investing our surplus to deliver member value and develop the profession for the next generation. Through our world leading ACCA Qualification, we offer everyone everywhere the opportunity to experience a rewarding career in accountancy, finance and management. And using our respected research, we lead the profession by answering todays questions and preparing us for tomorrow. Find out more about us at FOUNDATIONS FOR A SOUND TAX SYSTEM: SIMPLICITY, CERTAINTY AND STABILITY Simplicity, certainty and stability: in ACCAs view these are the three cornerstones of a good tax system. Policymakers should consider them any time they plan to change the tax system. They are also the benchmarks by which taxpayers can assess the effectiveness of government in maintaining and improving tax systems. Between 2013 and 2015, ACCA published a series of reports on Simplicity, Certainty and Stability in Tax, together with a summary report. This 2020 publication updates the summary report for developments in both the tax arena and the wider social, political and economic environment within which policy makers have to operate while remaining rooted in those original reports. REPORT AUTHOR Jason Piper, Head of tax and business law, ACCA Jason leads ACCAs policy work on the closely related fields of tax and business law, considering both the direct impacts of developments in each field and the wider implications for business and society as a whole. He has a background in tax practice, and degrees in European and International Commercial Law. Tax should exist to create benefits for society, not be a burden upon it Tax systems are fundamental to society. They are the conduit through which the state gathers the resources it needs to support public spending and are often the direct mechanism for implementing policy. Every citizen is affected by the operation of tax systems, and the efficiency and effectiveness of the system and its administration will have effects far beyond the direct impact of tax collection. Coming to terms with the impact of COVID-19 will intensify the focus on tax systems effects, both positive and negative, on economies and societies more broadly. Just at those economies and societies have grown ever more complex, so have their tax systems. As the world changes around them, tax systems must change to keep up. By the beginning of the 21st century, the arrival of the container, the executive jet and the internet had changed the face of world trade and domestic economies beyond anything previously envisaged. The still greater upheaval of the digitalising economy, transforming not just the way businesses operate but also the fundamental nature of products and consumer demands, highlighted the incompatibility of existing tax systems with social conditions. The enhanced mobility of goods, people and capital has transformed economies but the importance of tax in maintaining societies remains, and has been highlighted by the shock of the COVID-19 pandemic. As the global economy adapts to the impact of this novel coronavirus, governments will face the prospect of funding increased spending in societies where economic activity overall has declined and much of what remains may take place in very different ways to those envisaged when existing tax systems evolved. 1 The three functions of a tax system (revenue raising, redistribution and regulation of economic behaviour) will be achieved in different ways at different times. As policymakers react to change, and seek to influence it themselves, they will be faced with choices over what to tax, and how to do so. ACCA has identified three fundamental considerations which every system should strive for, and by which citizens can measure the success of governments and tax administrations in developing laws and processes, and the resources to administer them, for the greatest benefit of society. Regardless of the policies adopted by government, the design of the tax system used to fund or implement them should be optimised to achieve a balance between simplicity, certainty and stability. Introduction THE DESIGN OF THE TAX SYSTEM USED TO FUND OR IMPLEMENT THEM SHOULD BE OPTIMISED TO ACHIEVE A BALANCE BETWEEN SIMPLICITY, CERTAINTY AND STABILITY. 1 See our report, Sustainable Public Finances, downloadable from , accessed 30 July 2020. 4 different ways and have different tax rates. Historically, only the largest of businesses tended to operate in more than two jurisdictions, at most, and business models and transactions followed familiar patterns. The digitalisation of the wider economy has created new challenges, as trade and commerce can increasingly operate across the geographic national boundaries that separate tax jurisdictions. As economic operators supply goods and services in novel ways, which may not even have been contemplated when the tax codes were first written, so tax authorities are faced with fitting new business models into old tax codes. Assessing whether and where value that might be taxable has been realised is a novel challenge for businesses and tax authorities alike. What are the advantages of simplification? ACCA believes that a commitment to achieving simplicity in the tax system will produce the following benefits: n reduced cost of administration n greater accountability through clarity and transparency, and n improved stability, because the potential for unintended consequences and need for counteracting measures are both reduced. As noted above, reducing the administrative burden on business appears to be more strongly linked with economic growth than cutting tax rates. 1. Simplicity Understanding and complying with tax legislation should be as simple and straightforward as possible. 2 If taxpayers and their advisers face too complex a tax system and are unclear what is expected of them, this creates the potential for both mistakes and deliberate rule-breaking. Complexity in the tax system distorts the economy, diverting productive energies into non-productive administration. Why is tax so complicated? Tax systems can perform multiple roles: raising revenue, redistributing wealth and regulating behaviour (eg through excise duty on alcohol or green taxes). These aims may be achieved in several ways: by taxing spending (eg through Value Added Tax (VAT) or Goods and Services Tax (GST), receipts (personal or corporate income) or capital. Single taxes may be intended to support more than one aim. Implementing tax also has complexity: even when based on legislation, supplementary guidance or case law may be required to determine how the taxes will operate in practice. Tax authorities, taxpayers and advisers will interpret the rules not necessarily in the same ways. In practice, much of the complexity experienced by taxpayers and their advisers stems from policy implementation: confusing paperwork, ambiguous or inconsistent legislation and dysfunctional bureaucratic processes. Additional complexities are created when governments grant exemptions for certain taxpayers or draft anti-avoidance legislation. 3 Anti-avoidance legislation requires taxpayers to keep up to date with targeted rules, or to second guess the intentions of the legislature when trying to understand the tax impact of transactions. Taxes must also be calculated and assessed, which can happen in a variety of ways (eg by paper forms or online) and at different periods (eg annually, quarterly or on an ad hoc basis). Collection methods also differ. For example, with transactional taxes, it often isnt the taxpayer who remits the tax to the authorities (eg VAT and income tax on employment earnings). Taxpayers face even more complexity when operating across multiple jurisdictions, which may apply rules in 2 See our report, Simplicity in Tax, downloadable from , accessed 23 July 2020. 3 See ACCAs Global Policy on Taxation of Companies: Principles and Practices for further discussion of the complexity of tax avoidance. Downloadable from , accessed 23 July 2020. FOUNDATIONS FOR A SOUND TAX SYSTEM | SIMPLICITY, CERTAINTY AND STABILITY ECONOMIC GROWTH APPEARS TO BE MORE STRONGLY LINKED WITH REDUCING THE ADMINISTRATIVE BURDEN ON BUSINESS THAN WITH CUTTING TAX RATES. 5 FOUNDATIONS FOR A SOUND TAX SYSTEM | SIMPLICITY, CERTAINTY AND STABILITY How can greater simplicity be achieved? Technology can play a part in reducing the administrative burden on business, by enabling online filing, reducing the need for repeated taxpayer input, and even removing the human element from data input altogether. Many jurisdictions now base filings on accounts prepared in XBRL (Extensible Business Reporting Language), which is easily readable by other software. Simplicity can be encouraged by restricting adjustments to standards-compliant accounting when preparing tax computations. Where adjustments are necessary, these should be specified as clearly as possible. Drafting simpler tax legislation doesnt necessarily mean shorter legislation, but it does need to be usable and understandable. This is particularly important in countries where taxpayers self-assess their liability and will be the primary users of the legislation. The most fundamental driver of simplicity (or complexity) in a tax system is the intended function of the tax. A system designed purely to raise revenue is more likely to be simple, as the only design constraints are neutrality and efficiency. Mechanisms that introduce choices for taxpayers, and taxes designed to influence behaviour, are more likely to increase complexity. Policymakers should try not to make any one tax do too many things, and should not use too many different taxes to try to achieve the same aim for example, corporate income taxes become used to raise revenue, to redistribute corporate profits from the wealthy (the business owners who would otherwise ultimately benefit from the surplus), and to regulate business activity, through, for instance, enhanced deductions for installing environmentally friendly plant and machinery. Introducing these variously targeted aims inevitably results in complication. And then there is the potential for overlap: direct levies on carbon use or energy consumption have similar aims to the green elements of corporation tax. Governments trying to avoid waste and complexity in their tax system need to consider carefully whether they should operate two taxes with the same aim. Note that the concept of fairness doesnt necessarily align with simplicity. The simpler and less granular a tax system, the less finely it will be able to differentiate between the circumstances of different taxpayers. A flat tax is theoretically the ultimate in simplicity, but has no progressive element. In general, to encourage simplicity, the number of tax rules, and their ability to interact (or conflict) with each other, should be kept to a minimum. This also applies to international situations. Where a value chain is exposed to tax in a number of jurisdictions, the treatment should be aligned as closely as possible across them all, ideally through formal adoption of common rules and principles. THE NUMBER OF TAX RULES, AND THEIR ABILITY TO INTERACT (OR EVEN CONFLICT) WITH EACH OTHER, SHOULD BE KEPT TO A MINIMUM. TAX LAW AND TAX ADMINISTRATION SHOULD BE SIMPLE. SOCIETY AS A WHOLE PAYS THE PRICE FOR COMPLEXITY. 6 FOUNDATIONS FOR A SOUND TAX SYSTEM | SIMPLICITY, CERTAINTY AND STABILITY principles-based approach designed to protect society from unacceptable tax avoidance, but an inevitable cause of uncertainty. The involvement of the judiciary in interpreting tax law also has an impact. Judicial precedent can change overnight, while the appeals system and potential for multiple opinions can cause additional uncertainty for taxpayers. The treaty-based system of international tax (which follows legal form to allocate tax characteristics) has created some uncertainty for international businesses, which leaves opportunities for managers or owners to exploit. But the alternative unitary tax model introduces different uncertainties. Instead of taxing each companys locally accounted profits, such a system taxes a proportion of the whole (global) profits of the business on the basis of the proportion of its sales, assets and labour recorded in the jurisdiction. 4 Abuse of uncertainty Abuse of uncertainty poses risks to the exchequer. Taxpayers may seek to use it to their advantage when interpreting tax law, while tax officials may also seek an undue advantage, for themselves or the state. Corrupt tax officials could, for example, attempt to impose excessive tax demands in the hope of receiving a bribe. Extending discretion to tax authorities to do a deal poses a further risk to the tax system in the form of undisclosed state aid. Such deals will typically be limited to the largest multinationals or wealthiest individuals, and could give them significant advantages through lower effective tax rates. Deliberate uncertainty In some cases, taxpayers seek to introduce uncertainty deliberately, eg through an artificial avoidance scheme based on a tenuous interpretation of the law or facts. In practice, uncertainty usually results from the tax and accounting systems failure to capture the reality of a transaction clearly. 2. Certainty Certainty in a tax system is important because without it neither governments nor taxpayers can effectively budget or plan for their future actions. Yet every system incorporates uncertainty to some degree, and it may even be encouraged. Benefits of certainty Policymakers need to be able to base future spending plans on a realistic assessment of expected income. Certainty also benefits taxpayers. It helps them choose between alternative transactions, and to decide whether to proceed with an individual transaction. Where there is uncertainty over the tax position of a transaction, prudent taxpayers may reserve funds against the potential liability, restricting additional investment and so creating an opportunity cost. Where uncertainty leads to disputes between taxpayer and tax authority, the direct and indirect costs can be considerable. How uncertainty can arise Uncertainty can develop at
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