Dr Rodrigo Ormeño-Pérez Department of Accounting and Finance
Kemmy Business School, University of Limerick, Ireland

Lynne Oats Emeritus Professor of Taxation , The University of Exeter, UK

There is a never-ending debate about the legitimacy of taxpayers’ behaviour in the legal reduction of their tax liabilities by, inter alia, the (ab)use of loopholes and inaccuracies in the content of regulation, this is tax avoidance. Globally, this legal behaviour is frowned upon as it increases the tax gap, deprives States of resources to carry out part of its functions, and makes the tax system ineffective or unfair to some degree. But not only that, a plethora of new terms also has become common language, even between lay citizens, to describe that “abhorrent” behaviour. At the regulatory level, the Organisation for Economic Cooperation and Development (OECD) has intervened through the publication of soft law/guidelines that highlight some of the manipulable aspects of tax rules with international scope to be corrected via procedures in domestic tax codes in the hope of limiting the opportunities for tax avoidance to occur. Locally, States frequently modify the operation of their tax systems introducing either legal changes that close loopholes and correct inaccuracies of existing problematic regulation, or administrative changes that strengthen tax administrations’ capabilities to enforce rules more effectively.

The effects of problematic tax regulation are noticeable within tax administrations. In the article entitled “Implementing problematic tax regulation: Hysteresis and bureaucratic revolutionaries within tax administrations”, Lynne Oats and I examine the long adaptation process that the Chilean tax authority- the Servicio de Impuestos Internos (SII)- experienced to become as an effective enforcer of the first tax transfer pricing rule in the Chilean setting between its enactment in 1997 and its repeal in September 2012. Informed by interviews and documentary evidence, we provide a detailed account of how two characteristics of the domestic tax rule became particularly problematic during its implementation: namely, the absence of specific mandatory documentation requests and the incompleteness of the valuation methods section. The fact that multinational companies or any taxpayer with cross-border transactions with related third parties were not obliged to submit documentation (such a transfer pricing study or a specific affidavit, for example), made the SII tax officials’ enforcement work particularly challenging. In the words of the late tax administration expert and academic Richard Bird, competent personnel is one of the ingredients that makes tax administrations successful. However, as we illustrate in our article, the absence of mandatory documentation prevented tax officials from developing a thorough command of the practicalities of transfer pricing. Theoretical knowledge of the rule was insufficient to empower officials to apply the rule. As the case illustrates, documentation did not only serve as a source of information for tax authorities, but also as a fount of practical knowledge when officials examine taxpayers’ affairs. In its absence, tax officials were bound by their hands and feet from getting to the bottom of transfer pricing transactions. Interestingly, tax officials had to use their instinct to select audit cases, while in most instances their instinct failed creating material administrative costs. In cases where tax officials could access other information sources and audits started, they faced the challenge of incompleteness or ambiguity in the methods of valuation. 

Rather than following the OECD Transfer Pricing Guidelines of the time (1995) strictly, rule-makers customised its content to fit the Chilean tax environment introducing a previously unknown valuation method called reasonable profitability. As described by some interviewees, this method was largely ambiguous and could encompass any other valuation method, but without precise definition in the tax code. Obviously, this made tax officials’ selection of methods of valuation more problematic. In the timespan of 9 years, the problems of the rule made the SII’ work difficult, if not ineffective. As described in the paper, some high-profile managers and directors of multinationals wonder whether the Chilean tax code contained a transfer pricing rule or not, contributing to a taxpayers’ perception of an absence of control. 

For various political reasons, beyond the scope of the article, the transfer pricing rule remained unchanged for fifteen years. During this period, however, one newly appointed SII director (the highest authority in the tax authority) intervened to empower the institution in the enforcement of the existing rule to collect revenue, when possible, but also to evidence the problematic nature of the rule to motivate a legislative change in the future. This director landed in the SII with the conviction that this sense of having no control had to be corrected by the actual enforcement of the rule, and that companies in particular industries were manipulating prices to artificially reduce their tax liabilities. How did the director address this issue? Mostly by developing practical competence in tax officials. During this director’s period in office, tax officials were called to examine some specific transactions, getting to the bottom of them, in order to collect tax revenues. In those selected cases, tax officials had to document which aspects of the rule impeded them from collecting revenue. In this way, tax officials developed practical competence by auditing real cases, regardless of the outcome. Thus, the first (few) successful audit cases appeared, thereby reducing the sense of a lack of control. In other words, this director became a bureaucratic revolutionary. After that, tax officials became competent enough to effectively apply the transfer pricing regulation despite its complexities, paving the way for the new regulation promulgated in September 2012. 

Although this is a recent example of the problems occurring in a tax authority in a developing country, it broadly informs us about the challenges States face in the implementation of problematic rules. At the international level, this mismatch between the role of enforcer and the actual capabilities of tax administrations may become the norm for developing countries in light of the adoption of BEPS in emerging areas such as digital taxation or the global minimum tax. But also, this happens in the implementation of local regulation whenever the legislative output is deficient. We are left to wonder who should we blame for the ineffectiveness of tax rules? Should we blame technically compliant taxpayers, as distinct from tax evaders, who lawfully apply, and sometimes exploit, the content of problematic rules relevant to them reducing their liabilities? Christian Aste, a Chilean lawyer and active commentator, recently wrote an interesting metaphor on his LinkedIn site about tax avoidance: “Several politicians paint it in black and put it in the same box as tax evasion. Is that fair? Course not! As screws are not nails, tax avoidance is not evasion. Is it illegal to buy 2×1 items in a supermarket sale? No, we simply use our astuteness to pay less for more… in return, those companies bring employment and growth”. Then, should we blame tax authorities for their apparent ineffectiveness in terms of implementing the rules? In fairness, these two sets of actors did not formally craft those rules. Should we instead blame, or pay attention, to the regulatory process with its configuration of actors and institutional arrangements that favoured the creation of problematic tax regulation that leads to implementation problems and ultimately avoidance? Part of the answer seems to be there, and more attention needs to be paid to make tax policy-makers accountable.