Once upon a time, corporate structures were set up for efficiency: the efficiency of operations, of communications and of making as much profit as possible. Sometimes, this meant making the most of tax loopholes and tax havens, establishing entities in those jurisdictions that were more “tax-friendly” — which could mean as little as 0 percent corporate tax.
But after the global financial crisis of 2008, the people of the world grew weary of these loopholes and this culture of pursuing profit at all costs, and the OECD (Organization for Economic Cooperation and Development) introduced the Base Erosion and Profit Shifting project (BEPS). There are now 135 countries collaborating to put an end to tax avoidance strategies that exploit gaps and mismatches in tax rules to help entities avoid paying tax.
The regulatory push for more transparency
BEPS has translated into stricter regulation in most jurisdictions seeking transparency in tax strategies for entities. Around the world, corporate compliance managers and finance teams have had to work together to understand the way their entities have been structured, and to decide if there needs to be any movement to perfect tax strategies for entities.
There is no more hiding behind a dormant entity or shifting money to take advantage of a tax loophole. Tax strategies for entities today will likely be investigated by auditors and regulators, with some jurisdictions requiring these tax strategies for entities to be published publicly.
There’s also the need to consider economic substance when looking at tax strategies for entities. It may still be the case that you can set up an entity in a jurisdiction to act as a de facto HQ for a region without having a substantial presence there, but you can no longer use a shell company for these things. Economic substance emerged from the Council of the EU’s code of conduct for business taxation, which aims to counteract the effects of zero tax and preferential tax regimes around the world.
“Substance” requirements vary between jurisdictions, but the first step to assessing status is to take an inventory of all entities and make note of the type of company and how they are taxed. To be required to meet economic substance, the entity must carry on a relevant activity, such as banking, insurance, fund management, financing and leasing, shipping, distribution, holding entities or intellectual property. To display economic substance, an entity must show it is managed and directed in the jurisdiction, that core income-generating activities are undertaken in the jurisdiction in relation to the relevant activity, that there are adequate physical premises and suitably qualified employees in the jurisdiction, and more.
Both transparency around tax and around substance must inform tax strategies for entities, or else the entire structure will risk its compliance status.
Obligations Under the UK’s Finance Act 2016
For example, the UK published a revised Finance Act in 2016 that included the obligation to publish a tax strategy. This report must cover four main areas:
- The company’s approach to risk management and governance arrangements
- Its attitude to tax planning
- Its appetite for taking tax risks
- Its approach toward dealings with Her Majesty’s Revenue and Customs (HMRC)
The change was designed to dissuade the practice of setting up entities for tax evasion or avoidance, in line with BEPS and the underlying global attitude toward corporate tax matters.
What’s Market reviewed the tax strategy of 97 of the FTSE 100, and found a significant number went beyond the statutory requirements by providing additional information. Some of this additional information included the company’s total tax contribution, often on a country-by-country basis, as well as its transfer pricing policies, use and rationale for utilizing tax havens, and the company’s approach to the offense of failure to prevent the criminal facilitation of tax evasion (that is, what risk assessments they had in place).
Frequently, companies included a statement that they pay tax where value is created or where profits are made, and a statement that indicated some degree of “responsible” tax planning might be undertaken, such as to ensure that commercial transactions are undertaken in a tax-efficient manner or that they take advantage of statutory incentives and tax relief measures.
Design your corporate structure for optimal tax efficiency
When considering the corporate structure, tax is often a consideration. However, before you can perfect tax strategies for entities, you need to take a step back and understand the current position — to see what the current structure looks like, where entities are located, where there are any gaps or duplications, and where you may be falling afoul of the modern mood and tax environment. The most robust way to do this is by creating an entity diagram.
An entity diagram is a data visualization tool that aims to capture the full complexity of a modern enterprise. It’s a way to highlight structures at a glance, tapping into our basic learning needs and making a structure come to life on-screen. It can help you to understand the risks in legal entity structures, such as when you have the wrong entity type for the need, when your structure is unnecessarily complex, or when you’re in non-compliance with local regulation on substance and directorships.
And while you could create an entity diagram, also known as an organizational chart, by hand, poring over reams of spreadsheets and documentation to maybe get an almost-accurate result, the best way to work toward optimal tax strategies for entities and the group structure is by leveraging entity management software. These applications can pull in real-time, accurate entity data to create an organizational chart that is dynamic — you can drill down into the finer details and then zoom out to the big picture.
Entity management software, such as Diligent Entities, helps organizations to centralize, manage and effectively structure their corporate record to improve entity governance. This helps them to better ensure compliance, mitigate risk and improve decision-making through an integrated governance solution. Diligent Entities helps to surface the right information to the right people at the right time and creates a single source of truth for entities and structures.
By leveraging entity management software, compliance and risk managers and the wider finance team can get an accurate picture of the company’s tax position, and work toward perfecting tax strategies for entities. Get in touch and request a demo to see how Diligent Entities’ organizational diagramming and other entity management functionality can help you to perfect tax strategies for all entities across your legal subsidiary structure.