16 - Auditing Financial Markets

1. 16 - Auditing Financial Markets

2. Managing Compliance Risks arising from Financial Instruments • Policy and legislation • Appropriate rules • Including anti avoidance rules • Administrative approaches • Determinations and rulings process • Advanced pricing arrangements (APAs) on financial arrangements between related parties to deal with transfer pricing issues • Disclosures of complex financial arrangements • Audits of complex financial arrangements • Specialised technical skills

3. Policy and Legislation • Sound legislative framework to facilitate financial innovation • Eg Repos taxed as secured loans • Much aggressive tax planning based on exploiting perceived weaknesses in legislation • Objective of legislation should be • To be clear in purpose • Trust courts to interpret in a way that is compatible with that purpose

4. Policy and Legislation • Design legislation with avoidance opportunities in mind • A clear statement of purpose “principles based drafting” is one tool for making law robust and assists courts in interpreting legislation in a way that fits original intention • Another strategy is to incorporate anti avoidance legislation into the primary legislation as it is introduced

5. Policy and Legislation • But • No matter how good the proofing of legislation is there is always the risk that someone will find a way round the legislation • Good primary legislation may reduce the planning opportunities, but it will not eliminate them entirely. • Other defences needed.

6. Anti- Avoidance Legislation • Anti avoidance measures • General Anti Avoidance Rule (GAAR) • Specific Anti Avoidance Rules • GAARs can be effective but not a cure all • In particular cannot be used to remedy defective primary legislation eg Japan on REPOS, Canada fully hedged foreign currency loans, • Some legal systems cannot incorporate a GAAR

7. Anti- Avoidance Legislation • Specific anti avoidance legislation e.g. UK targets arrangements • One of the main purposes of which is to … • Generate capital losses • To secure a tax advantage • Retroactive legislation • Full rectro active (illegal in many countries) • Partial retroactive (illegal in some countries e.g. France Italy) • Partial retro active legislation can be effective when coupled with disclosures regime (see later)

8. Determinations and Rulings • Rationale • Determinations can be issued by tax authorities or requested by taxpayers on • Generic type of instruments (e.g. options, swaps, etc.) • Product or arrangement specific • Taxpayer specific • Practical Issues • Fees to cover costs • Transparency in public and private rulings (publish principles anonymously) • Can be challenged

9. Disclosure Requirements • Purpose is to provide tax authorities with information about complex financial arrangements with tax avoidance implications • Use as an audit selection basis to determine whether to investigate further • Focus on complex related arrangements, but ‘relatedness’ is difficult to define • Exempt inter-related arrangements that are generally accepted commercial practice (e.g. hedges) • Look in more detail at UK disclosure regime

10. Administrative Approach • Financial instruments are complex, with own specialist terminology, accounting and tax rules • Tax administrations need to be able to handle this • Specialist units • Accountancy skills

11. Administrative Approach • Improve commercial awareness of staff • Ask banks to provide training? • Banks allow staff to be seconded for short periods? • Recruit private sector financial specialists? • Enhanced relationship with banks • Work with banks through rulings, guidance real time discussion • Encourage banks to be transparent so as to better understand the commercial context of complex financial instruments • Banks need an incentive to behave this way

12. Administrative Approach • Risk assessment • Ensure have strategies in place to better prevent, detect and respond to aggressive tax planning involving financial instruments • Auditors should alert policy makers to use of financial instruments • E.g. where transactions comply with law yet have undesirable effects

13. Administrative Approach • Auditors should alert policy makers to use of financial instruments • E.g. situations where transactions are treated differently in another jurisdiction to determine whether the policy makers are comfortable with existence of arbitrage opportunity (see later session)

14. Auditing • Many financial avoidance schemes work and important role of auditor is to bring such schemes to attention of policy makers • However, not all of them work, especially if they don’t get the paperwork right • Know your taxpayer. Are they prone to making mistakes. If so they may mess up an otherwise effective scheme

15. Auditing • Audit approach • Understand the accounting • Understand the financial products • Is the tax treatment achieved by taxpayer consistent with objectives of legislation • If not, what are your available tools • Are all the considerations of a financial arrangement included in your calculation? • When are two arrangements independent or interdependent?

16. Auditing • Things to look for • Accounting profits, but no tax profit • Items treated as income/interest for accounting purposes but as capital for tax purposes • Losses on currencies/assets when no obvious commercial reason for holding those assets • Several Transactions happening at same time • Self cancelling transaction

17. Auditing • Things to look for • Differences between consolidated financial expenses and individual company tax returns • Transactions with associated enterprises • Transactions with non tax paying entities (charities, tax havens, loss making companies)

18. Auditing • Things to ask for • Contracts on financial instruments • Master agreement between bank and the MNE • Commercial reasons for entering into contract • Documentation to meet accounting or regulatory requirements • [ Know the accounting and regulatory requirements]