Tax Relief in Global Markets: A Step Forward – or a Step Back?


Tax Relief in Global Markets: A Step Forward – or a Step Back?

June 2019

This blog is a continuation of our series exploring the tax and regulatory landscape, which was presented in detail at the Annual EMEA Tax and Regulatory Client Forum.


Today we are facing an unprecedented amount of tax change. Fiscal pressures and market protectionism are no longer the sole drivers - tax changes are clearly being driven by policies that are focusing on the clampdown on tax evasion, resulting in governments and regulators looking for transparency, data, and information.


Tax authorities and regulators are equipping themselves with enhanced data and analytical capabilities. The goal for the use of that data is to improve their governance and identify abusive tax transactions while seamlessly sharing information - it’s clear that industry needs to do more to keep up.


As we look to the future and the role that technology will play, Financial Institutions have to be ambitious, aspirational and move beyond intent. Creating an organisation that thinks differently about the future of digital and sees it as a value and not, as something that merely manages the process.


Historically, an investment firm’s tax department has not focused on technology. But a tipping point is close; tax authorities are aggressively pushing a digital agenda and producing new regulations on data and reporting. In the UK, for example, HM Revenue and Customs (HMRC) is now hiring more data scientists than tax inspectors and is on the way to becoming a digital authority.


These developments are challenging for asset managers, many of which have small tax departments. The advent of regulations such as the Foreign Account Tax Compliance Act (FACTA) means that many parts of the organisation are now involved in tax issues. However, data is often fragmented and inconsistent. Cost cutting in some firms’ tax departments has compounded these challenges.


Investments in technology can yield significant results; many existing tax processes are manual, slow and expensive. Technology has evolved in recent years, creating massive opportunities. New tools such as analytics and AI help market participants to achieve tactical benefits - such as a better understanding of obligations; improved oversight; or more effective tracking of compliance. Benefits are not just confined to the tax function: deeper tax insights should also enhance the quality of investment decision making.


Perhaps the greatest technology-related challenge facing the tax function is data. Data is extremely valuable but to realise that value and make strategic advances, rather than simply the tactical improvements described above, it is necessary not only to establish where data is located in the organisation, but also to bring it together and improve its quality. This is easier said than done. Improving data quality (and other related projects such as developing a taxonomy) on a limited investment budget is challenging.


One potential solution to firms’ budgetary challenges is to collaborate with other parts of their business that are already using analytics or planning to develop projects. The tax function is sometimes forgotten within companies: it needs to articulate the benefits of its involvement both in terms of cost savings and firm-wide risk management. Another option to develop digital capabilities cost effectively is to cooperate outside the organisation; in many instances tax is not a competitive advantage. Cleaner, better categorised data is an industry challenge that would benefit from a common approach.


The Role of Utilities


Where common challenges exist across the industry, there are potential opportunities to build utilities that offer messaging and other infrastructure. Utilities can reduce costs and mutualise risk in areas that are non-competitive and do not offer a point of differentiation. They are widely used in some parts of the financial services industry, for example in relation to Know Your Client (KYC) regulations and EU Directives such as the Shareholder Rights Directive (SRD) are exploring utility solutions across industry to enable compliance.


To date, tax functions have not used utilities. However, there are potential opportunities for tax utilities to provide standards, storage, and therefore help improve the integrity of data. To be sure, significant challenges exist, including the use of legacy technology and processes, the issue of liability, and the fact that – to some extent – elements of the tax function may be a competitive advantage.


It is important to remember, however, that there is no current known requirement to create a single all-encompassing utility. Instead, it may be easier for the tax industry to focus on standards and inter-operability. Similarly, there are other ways to lower costs and share risks - partnerships and other types of collaboration are potentially as valuable as utilities. One important requirement for any type of shared tax services function is likely to be the involvement of regulators and agencies, however.


The Potential of DLT


Distributed ledger technology (DLT) and blockchain are best known for their role in underpinning cryptocurrencies. However, they have also been extensively trialled by the financial services community for a variety of functions, including trade finance and foreign exchange. DLT technology has the potential to help utilities serving the tax function. For example, tax relief claims on cross-border investment is one of the industry’s greatest challenges; a technology that offers a single replicated, shared, and synchronised digital ledger simultaneously across multiple locations seems ideally suited to the task.


One key consideration when designing a DLT solution is to ensure that all players in the blockchain derive value from it. This should include asset managers, brokers, sub-custodians, tax advisers, and tax authorities; DLT could make it easier for authorities to identify ultimate beneficial ownership and improve transparency of end-to-end processes, for example.


While it would be possible for private sector market participants to adopt a DLT solution alone, it seems likely that a solution that encompasses all parties (including tax authorities) would deliver greater value. Not all authorities might be willing to participate. However, it might be possible to achieve many of the same benefits simply by linking a DLT solution to the tax authorities through a messaging system for example, rather than embedding them in the solution.


A Cultural Change


Investment in technology is growing across all companies. The tax function needs to build a clear business case to ensure that it receives its fair share: it must become more assertive about the value that it delivers to the organisation and push for increased investment budgets. Meanwhile, in order to ensure that money is spent as effectively as possible, there is a pressing need for discussion and collaboration about standards, taxonomy and best practice within the industry.


While digitisation will deliver myriad benefits to the tax function, it is also important to guard against risks. As younger digital natives take leadership positions in departments and technology automates basic tasks, there is a risk of overlooking some of the complexities and nuances inherent in tax, with possible risk management consequences. Any digital transformation of tax must therefore take into account the need to identify and map all existing processes before implementing new technologies and ensure that the decades of experience, which are integral to the efficient operation of tax departments, are shared in the new digital age.


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