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The Taxation of the Financial Sector: an Opacity to Overcome
There is much debate about the tax rate on the profits of the financial sector. It is important in itself this debate and offers an overview of the fiscal issues of the moment: the effect of the internationalization of groups on their coning rate in a fiscally divided world, the distribution of obligations to impose between states, and the impact of the use of financial “leverages” to manage the tax burden of companies.
Overcoming these problems, it appears that a considerable need for clarification remains to be met. Indeed, the extent of the activity of the banks presents particular difficulties illustrated by the diversity of approaches followed and the accounting arbitrages with very high stakes on which it depends. On the other hand, a particular problem must be considered, which is the combination of the difficulties mentioned with the internationalization of the big banks, which offers an additional element of opacity.
In this instance, what is the real situation of compulsory levies on financial sector taxation regarding the real level of the sector’s tax rate? It is necessary to understand that the demands are to improve the transparency of information disseminated by companies in the sector and to make available to researchers the data held by regulators help to identify this exit. These requests are in line with the concerns of decision-makers looking for devices intendeds to learn more about the activity of banks in the different countries where they operate.
This need for transparency responds to a variety of public interests, including a better understanding of the financial risks posed by offshore banks and their tax contribution. In this instance, a few common sense considerations should be invited as a preliminary point of view. “Too big to fail” syndrome is a problem for financial stability because of the likelihood of moral hazard that may include uncertainties about the quality of supervision. It may apply to certain aspects of tax control for a variety of reasons.
First, there is a structural problem in the management of the tax of the entities in question. With a total balance sheet of GDP in several developed countries, it is not unreasonable to consider that the tax result of some local banks, which is dependent on net assets derived from a number of incalculable transactions, which are also carried out under differentiated tax statutes, may be influenced by trade-offs that lead to the view of it as more or less the product of a negotiation.
If consideration of the implications of tax rules obviously matters, referring to a form of “political management” of taxation, probably offers an image that is not totally unrealistic to reflect the tax problem posed by institutions under review. This approach does not exclude the rigorous application of the tax law nor may that inevitable conflicts arise admit a certain harshness. It is therefore necessary to consider whether the system of monitoring the sincerity of tax transactions works properly or, on the other hand, has more or less obvious failures. However, it must be recognized that the tax result of such large sets cannot mechanically respond to a legal arithmetic without flexibility.
It is under these conditions that we must go back to the debate on the tax rate actually bound by bank establishments in each country. This seems to address, among other things, the question of the implicit tax rate of broad companies compared with the theoretical rate and that applied to smaller companies. Yet, in his own way, he engages the same questions. The relationship between the contributory capacity of banks and their effective tax contribution is very difficult to assess in a context where tax rules are added to opaque communication to maintain some confusion.
Also, the difficulties of economic measurement of financial sendees, the financial sector, and national accounting foim a household difficult to unravel. Indeed, the national accounts of countries, which amis to measure the production of resident economic entities and the corresponding income distribution operations between the factors of production and the other stakeholders (in particular, public administrations and levies on the incomes of other agents) applies specific methods to the financial sector to adapt to the specifics of financial activities.
There are two main difficulties: the lack of billing for a significant part of the business activity of companies in the sector and the share of this activity and its results by financial transactions, which, for other sectors, most of the national accounts of rich countries, has chosen not to identify for cunent production activities.
This latter choice is maintained by national accountants who, however, aware of the resulting loss of information for the financial sector, also publish an indicator, excluding national accounting, to move from value added to an index closer to the reality of banking activities, net banking income. Assuming the data published in the national account format in some countries excludes the results of the banks’ own-account market activities (customer-based activities that give rise to collection commissions integrated into the sector’s production for the amount of these commissions).
As for the first problem, which arises for other service activities, it is solved by the addition of the revenues charged by banks (such as commissions) of calculated revenues (indirectly measured financial intermediation services) to calculate production, and therefore the added value of the sector. The financial intermediation services indirectly measured era are based on the margins found on deposits and on the credits of banks considered to be representative of the price of services rendered by the financial sector and thus the value of its production. This is, of course, a veiy unsatisfactory approximation since the measurement of the added value of the financial services sector comes out dependent on exogenous variables which can induce changes unrelated to the services offered by the financial sector.
Moreover, this method is based on choices that technically are far from indisputable. These observations are not only theoretical in what it appears that the valuation of financial services depends on the valuation of gross domestic product. However, GDP tends to become a benchmark for the implementation of a series of policies. For example, it is used to calculate the necessary contributions to the budget and to implement systems of economic and budgetary discipline that can play a decisive role in defining economic policy directions. In countries where the financial sector is relatively high, the sensitivity of GDP to questionable accounting policies (especially because they involve essentially exogenous and difficult-to-handle variables) is strong. It can lead to GDP estimates that are only partially reliable with operational consequences on the contribution to the budget and the definition of economic policy directions.
However, the net banking approach does not dispel opacity. Net banking income is similar to a concept of financial availability associated with the activity of banks and used to cover their operating costs (wages, taxes, etc.). Overall, net banking income is twice as high as the value added (only included in GDP) recorded by the national accounts. The difference is mainly due to the consideration of the banks’ net financial income and the capital gains recorded in the revaluation accounts. With regard to financial revenues, it is noted that the net interest of the banking sector has led to a decrease in gross national product, which is obviously not structural.
The interests in question are not those corresponding to client relationships that are counted as financial intermediation sendees indirectly measured in the value-added estimate. They are the result of interbank refinancing operations, which include refinancing at the end of the issuing institute. On the other hand, the net dividends received by banks are structurally positive. They reflect the assets held by resident banks, which are an important component of their balance sheets. Their contribution to gross national product can reach a high level (21.7%) and their evolution can sometimes cushion the decline in profitability of other net assets of banks.
These observations point to the sensitivity of banks' results to the profitability of their nonloan financial assets. This is even more evident when one considers the effect on GNP of capital gains. More than 50% of GDP is directly dependent on market operations in some rich countries, which moderates the vision of a banking industry dedicated to financing the economy through credit that would constitute a specificity shared by some and radically opposed the situation in the United States.
The universal banks of some countries actually stand out as dual, dependent not only on their lending activity but also on their market activities. In the first approximation, in addition to the comparative magnitude of it, the real difference comes from the nature of the resources mobilized to finance their market activities. There is a large discrepancy between published net banking income estimates. The gap for the year amounts to nearly S51.8 billion on average. The differences appear to stem mainly from the conventions specific to each evaluation, with some institutions focusing on isolating the municipal soil component of GNP, while data published by other institutions are calculated on the basis of consolidated accounts (limited to the first six banking groups by countiy). They integrate all the activities of these groups around the world. The differences between the GNPs identified give an approximate picture of the contribution of banks’ activities abroad to their resources. It emerges as high which reflects the international deployment of these groups.
A fundamental question then arises when, whether private accounting is a field open to arbitration? The accounting of financial firms serves indeed, to inform investors but also the public community and is as such a tool of transparency. It is also at the foundation of determining the taxes result of companies, albeit with nuances. As an instrument of transparency and social responsibility, accounting poses problems that appear to be in the process of solving. As a tax base, it refers to the accounting leeway available when determining the financial companies’ bottom line in these terms: the determination of taxable income that depends on all transactions of any kind year and the change in the value of net assets offers multiple levers to optimize the taxable base. In particular, the rules for valuing the valuation of securities held in assets (and thus the amount of impairment provisions that result and allow the resulting impairment provisions to be lowered (taxable) offer some leeway.
For credit institutions, securities held (equity, portfolio securities, and long-term held securities) may be provisioned for impairment once a latent impairment is found. For investment securities, a proven credit risk must be demonstrated. This is also the case for depreciable investments (i.e., bonds) of insurers, other investments (equities, real estate, etc.) that are subject to a depreciation provision where the loss of value observed is sustainable. Insurers must also provide a provision for the risk of liability if their funds are generally in latent impairment, which is tax deductible under certain conditions.
The calculation of certain technical provisions to the liabilities of insurers has tax consequences. Indeed, if they are reduced, they allow for a higher net profit (with therefore positive consequences for corporate tax revenues). The accounting, prudential and tax rules currently applicable to insurers are broadly aligned: differences in interpretation (assessment of probable charges, in particular) are gradually settled by the alignment of fiscal and piudential doctrines. The choices of valuation of net assets mobilize problems of extreme complexity that are illustrated by the endless discussions on accounting standards, and even more so the testing of accounting standards by the last financial crisis.
On the other hand, there are practical problems. First, the gigantism of some institutions leads to questions about the reliability of methods of checking accounting registrations, especially since they are doubled by countless transactions and business relationships as well as complexity of transactions that can include difficult-to-control time lags. On the other hand, the dive of the spaces in which financial institutions intervene, the failures of accounting standards and their application in offshore centers, despite the expansion of the prerogatives of supervisors (accounts shall be held, etc.), require relativizing the scope and significance of controls.
Accounting failures contribute to opacity, which is a risk factor for capital evasion. The regulator, when reviewing a country, verifies that it meets accounting standards under which any entity or arrangement domiciled in or related to its territory meets the following obligations: the accounting must trace all transactions and determine the financial situation of the entity concerned. It must be accompanied by all supporting documents and it must be kept for a minimum of five years. These obligations must be included in national regulations.
ExpertActions ExiGlobal group has found many failures in this regard. For example, a side of the attractiveness of international business companies in some Caribbean countries is based on the lightness of obligations and accounting products. This situation is not isolated. Of the 97 states assessed by the group, 47 were found to be below the standards used, 28 of these states had such failures that in relation to this criterion they were rated as “non-compliant.” In some cases, the failure to maintain accounting requirements for certain structures must be noted.
For example, in the Cayman Islands or the British Virgin Islands, the accounting of partnerships or trusts is generally not retained. In the free zones, entities are exempt from any accounting obligations. The same applies to entities present in a large number of jurisdictions provided that they do not operate in those jurisdictions. It is a peculiarity of tax havens to offer legal benefits under the condition of nonactivity on the spot. ExpertActions Group notes, however, that progress has been made in some countries while others have been announced elsewhere.
The progress mentioned will have to be rigorously verified. But, it should be noted that the completeness of accounting information is one of those requirements that are relatively unlikely to have guaranteed concrete extensions as long as accounting controls remain little, if any, organized and as long as the owners’ entities will remain difficult to identify. On this point, it should be remembered that scans financial tales which have been primarily accounting scandals (Enron, WorldCom, etc.) have led to strengthening the governance of accounting controls. In particular, high advice from the auditor’s office in different countries with the task of issuing advice on accounting controls and supervising audits commissions to accounts. This is a happy innovation that, however, does not solve the whole problem of account control.
With regard to these structures themselves, we must regret the weakness of the means granted to them. From a more functional point of view, it is timely to questions the application to the scope of accounting ethics of a formula, often encountered, which involves the attribution of a first-degree disciplinary body to a professional body with an intervention on appeal by an authority Administrative. This system results in a foim of privatization of disciplinary matters that are controlled outside the profession only when sanctions occur. It does not appear fully suited to the concern to prevent any conflict of interest.
Moreover, it is the very conditions in which auditors in several countries intervene that fall under this question. In this regard, it is important to reiterate that, despite a strengthening of the legal framework for the practice of the profession, auditors who do not have an active approach to tax evasion have a duty of care which applies to tax matters, but that, even framed by a standard of professional practice, is described as obedient to a means obligation, leading to somewhat random discoveries. Moreover, few revelations are made—0.4% of the warrants give rise to it—and the practice seems even less common for the facts of money laundering since, according to the indications, only 46 statements were addressed this year.
In these circumstances, however, it is necessary to observe that, on this point, some countries are distinguished by the express unveiling of an obligation to disclose that their partners do not generally do not foresee. This point should be subject to international harmonization, except to reinforce the feeling of a fight against tax evasion with variable geometry. On the other hand, a recurring conflict of interest problem exists because of the nature of the commercial relationship between the commissioners and the companies controlled by them. In these circumstances, given the links between the determination of tax profit and the accounting results of financial firms, it is understandable that accounting uncertainties may be reflected in certain tax vagaries.
So what about veiy allusive financial communication? Moreover, the financial communication of companies obscures the tax dimension of their activities. The reconciliation between the tax data published by companies and their consolidated accounts provides only partial information on the tax contribution of companies and the rate of tax effort they actually bear.
In their own way, the data mentioned illustrate this imperfection, leaving the moderately informed reader somewhat perplexed.
According to corporate accounting, the cumulative amount of corporate taxes reached (per rich country excluding the United States) 8.57 billion for the top four banks in the rich countries. The apparent discordance can be explained by the differences in the field and statistical population to which each relates. But these explanations do not add much to the legibility of the tax effort of the companies in question. Further observation is required regarding the quality of information disseminated on this point by supervisors.
Monetary authorities regularly publish information on the situation of banks. The evolution of the GNP of six local banking groups and their distribution between different jobs was extracted. A line lists taxes. It would be good if the information presented was more complete. The taxes mentioned include all of the recorded taxes that are compared to GNP and the group’s consolidated interim management balances, which are compiled, moreover, on the basis of the financial information provided alone companies involved. The presentation thus made induces distant assessments of the reality of the tax burden ultimately borne by these companies. Some of the deductions recorded will be compensated, in particular, due to the elimination of double taxation. On the other hand, the effects of deficit deferrals will still have to be reckoned with.
In addition to this problem of the significance of the published data, there are also those already mentioned of the completeness of the information relayed by the monetary authority from the financial statements of companies: there is no disaggregation of tax data by country or by line of business, let alone that there is no indication of the local contributory effort rate of the companies covered by the statistics concerned. In the future, this situation should change. Some of them provisions recent will improve information on this issue. It will be necessary, however, to ensure that the reference to the consolidation perimeter, ultimately adopted, does not allow for an alteration of the information.
It is known that the choices of companies may vary on this point and that structures may be excluded from the scope of accounting consolidation for lack of “materiality” due to a demanding conception of the latter criterion. For example, some banks estimate that an entity with less than S500 million in total balance sheet straits is presumed to be negligible in the setting of accounts consolidated. The same applies to entities with a net profit before tax of less than $1 million.
No doubt, it will be necessary to ensure that the system is fully coherent. This should enrich the financial information of the mention, for each significant “joint venture,” by the reporting entity of the charge or income tax proceeds, beyond the capital links between the filer and the entity regardless of its consolidation in the registrant's accounts. The margin left to institutions to define the scope of their accounting consolidation is problematic. It should no doubt be noted that the choices are controlled by the auditors and that they are not exclusive to any information on excluded entities whose results are assumed to be taxable.
But, by definition, there is a “lamp effect” that leads to focusing on the entities identified in the scope of accounting consolidation so that the control of accounts can be exercised less acutely on what is excluded. On the other hand, the quality of information that is an off-balance sheet or that it is collected in commercial registers may be less than that available when the entity is controlled. It is still necessary to count on the administrative shortcomings of some jurisdictions which combined with the existence of opaque legal structures can result in a complete lack of information on structures linked to large groups bank but eventually sucked into a black hole of information.
In this context, determining the taxable base of financial institutions is particularly complex. Corporate accounting lists the margins noting that the techniques described are “not unique to financial companies, but for them the liquidity of their balance sheets and the nature of their business are well-used.” Corporate accounting distinguishes between “tax regimes commonly used by companies and in accordance with tax rales and practices to artificially create a deficit, which tests the imitations tax legality.” A number of elements of the tax legislation result in an adjustment of the taxable base to what it would be in the event that all income would be taxed:
Intertemporal deficit management, which allows deficits to be carried forward or backward under conditions.
The mother-daughter scheme, which guarantees the deductibility of profits paid in the form of dividends by subsidiaries.
Tax integration, which allows an entity’s losses to be attributed to the profits of the parent company under conditions as well.
It is also worth mentioning the abundant source of tax legislation for all bilateral convents concluded by each country with foreign states.
Risk is part of normal economic life and its materialization may represent a deductible expense of the proceeds for determining the tax result of companies. Deductibility, however, is waived when certain conditions are met. In some decisions, some legislators have clarified the circumstances under which a loss cannot be inferred. In addition to the traditional cases of abnormal management acts, these countries considered that the clear deficiencies of the executives in the organization of the company and the implementation of the control sets could limit to the deduction of a loss.
This standard on the deductibility of a loss due to risks taken by an employee, however, seems to draw narrow limits to the margins of appreciation of intelligence and action services clandestine financial channels to deny the deductibility of a loss. Excessive risk-taking can be an abnormal act of management but under very strict conditions. The deliberate lack of controls akin to encouraging statements that regular operation of the controls would not have permitted can be used to reject a loss as a result of the risks taken. It is necessary lifts that, contrary to a general trend in society, the legislator does not stand out as an adversary of risk. Current comments on the propensity of some financial players, responding to ill-conceived incentives, including those attached to the remuneration systems, to engage in adventurous positions whose costs are ultimately supported by the community could perhaps lead to judicial developments on this point, even if they appear logically dependent on changes in the prudential rales adopted elsewhere.
In this context, the fact remains that the intelligence and action service against clandestine financial circuits would be well advised to systematically advise the high courts, the opportunity for losses incurred as a result of risk-taking that may appear to result from organizational deficiencies or controls on the various commitments of banks, when they involve tax issues of some importance.
National opinions have been made attentive to the particular difficulties encountered in the case of the loss caused to some large banks by open positions structured products. In these cases, cases which is a major issue for the public finances—$ 1.7 billion on average per country at first approximation, it appears that significant “failures” of internal control, proven by a sanction against the establishment by the supervisors, but also by certain alleged events have occurred. Without deciding on the substance, it is can only observe that a specific consultation regulator could have brought legal security supplementary to tax treatment of this episode and wonders about the prospects there are still ways to do so.
Regarding the aggressiveness of practices and other problems, certain schemes consisting of attributing the results to the best tax interests of financial companies but which may appear abusive. Regarding hybrid devices, several schemes that allow either a double deduction or a deduction with no inclusion in the highest tax country, or the creation of foreign tax credits. Technical literature tends to proliferate on these issues. The sophistication of financial engineering techniques are impressive. It is important to identify certain structures that need to attract the attention of tax control and prudential control. Moreover, the number of tax schemes considered to be capable of an abusive tax optimization intention continues to increase.
Before these clever schemes, for financial sector institutions, as for other companies, the more ordinary possibilities of transferring results associated with the determination of internal transfer prices, as well as the difficulties referred to in arbitrations on the territorial attachment of income. However, it is important reducing problems have transfer prices on financial products are the simplest, with those relating to brands being, for example, much more complex.
This simplicity, however, is related because the tax dispute is whether a group, when lending to one of its subsidiaries, should lend at the rate at which the group could borrow, or at the rate at which the subsidiaiy, if it were fully independent, could borrow. The rules need to be clarified. Transfer prices on market activities are extremely complex, as these activities are highly integrated. Each case is unique.
The difficulties mentioned do not concern financial enterprises exclusively, but they are particularly concerned because of their activities. The complexity of the subject is somewhat illustrated by the example of transfer prices. The different reports about each sector of activity, for an entity that does not have a local international activity, but which, it is true, depends on a world-class parent company. Upstream, there is a problem: determining where financial activities should be taxed. It raises problems similar to those raised by digital taxation. In the context of financial internationalization, the dissociation between countries of registration of bodies, of the source of funds and of management is commonplace. Where to tax income from financial activities?
The prospect of a considerable development of e-finance should lead to the very rapid consideration of how to prevent its effects on public finances. Already, the existence of structures registered in countries with advantageous taxation and managed remotely leads to questions about the capacity of intelligence and circuit-based services to apprehend easily relocated income. This question refers to a series of technical problems (such as the definition of stable institutions).