Financial Transparency Coalition

This year, the European Union will review a number of European laws that spell out what types of information companies must disclose in their annual financial reports. Although at first sight this change in accounting rules seems like a dull technical exercise, well designed and transparent accounting standards have the potential to lift the veil of opacity that has contributed to the recent global financial drama and which, for years, has been preventing developing countries from properly taxing the activities of multinational companies operating within their jurisdictions.

Civil society groups are calling on the European Union to live up to the highest standards of financial integrity and, by making the right legislative decisions on EU accounting rules, to help curb the untaxed USD 800 billion that flows out of developing countries each year.

Why are European accounting laws crucial for the fight against capital flight?

Firstly, European accounting laws (EU Directives) are legally binding for all companies within the European Union who invest as much as €290 billion a year in countries outside the EU (according to latest 2009 figures). This figure represents more than one third of global foreign direct investment (FDI). Hence, EU accounting laws could have a massive impact in the financial transparency of a big share of investments across the world.

Secondly, the review of the EU legislation comes right after the approval of the Dodd-Frank bill in the U.S. Congress in July 2010, a groundbreaking Act which will require all U.S.-listed companies that are active in the extractive sector to report the payments made in each country in which they operate (including any taxes they paid). The United States has set high benchmarks of financial transparency with this rule. Now it is the EU’s turn to show political leadership on the fight against tax evasion and raise the bar even higher by requiring all companies in all sectors to report disaggregated financial information, including taxes paid in developing countries in which they operate.

What laws are being reviewed?

The EU directives under revision are:

• the directives on consolidated accounts of companies with limited liability (Forth and Seventh Directive), which lay down rules on financial disclosure. The consolidated accounts, the consolidated annual report and the auditor’s report of EU companies must be published in accordance with the provisions of these directives; and
• the Transparency Obligations Directive (TOD), which contains transparency requirements for listed companies.

Directives on consolidated accounts (Fourth and Seventh directives)

As we write this article, the European Commission (EC) is beginning its review process for the Fourth and Seventh directives. The financial reporting unit in its DG Internal Market department will make a proposal for reviewing these directives, which will then be sent to the European Parliament and the Council in June 2011. Although the process to adopt the amended directives may easily stretch out until 2013, it is crucial to influence the process during the early stages, because this is when the EC drafts the amended text.

The Forth Company Law Directive coordinates national laws on the annual accounts companies with limited liability, while the Seventh Company Law Directive spells out requirements regarding consolidated accounts of all companies, publicly listed or not. The Seventh directive covers issues on the methods drawing up consolidated accounts, including issues such as intra-group transactions, the average number of persons employed and profit/loss figures.

Civil society groups, independent experts and some companies believe that this would be the most appropriate EU law to require non-listed companies to disaggregate their accounts on a country-by-country basis. This could provide developing country tax authorities with the necessary information to effectively tax the activities of MNCs operating in their jurisdiction.

Transparency Obligations Directive of listed companies

The TOD Directive contains transparency requirements of listed companies whose securities are traded on a regulated market, in order to meet investors and capital providers’ information needs. The current version of the directive suggests that extractive companies could disaggregate their financial information on a country-by-country basis; however, the directive does not contain a binding requirement and does not make reference to companies outside the extractive sector.

The process to review the Transparency Obligations Directive (TOD) already started last year. It was supposed to be part of a broader package on financial supervision proposed by the Commission, the Omnibus directive, which European legislators felt was important in light of the global financial crisis. Eventually, the EC decided to de-link the review of the TOD from the broader package, and it now seems that the EC aims to submit a proposal to the Parliament and the Council in October 2011.

It is crucial that civil society pressures the European Commission to include provisions to make country-by-country reporting a binding requisite for all listed companies in all sectors in the reviewed text that will go to the Council and Parliament in October.

It is also worth noting that after a strong campaign by CSOs and parliamentarians that would like to see EU financial transparency enhanced, the European Commission is also drafting a non-legislative proposal (a Commission’s Communication) which spells out the ways in which country-by-country reporting standards could be included in existing EU laws. However, it is still unclear what the Commission’s advice will be; their position is due to be released in September.

Next steps for curbing tax dodging in Europe

As the Commission starts drafting the proposals for the revised versions of these directives, civil society should scale up efforts to pressure the Commission and other EU bodies to ensure that country-by-country reporting requirements are included in the texts to ensure that EU accounting and transparency laws stop providing a smoke screen for tax dodging.

However, this is just the beginning of a long legislative process, as we do not expect the Parliament and the Council to approve the final texts until 2013, or beyond. This will require sustained campaigning at the domestic level in EU Member States to make sure the proposals for financial integrity receive sufficient support from the European capitals.

This will be long distance race, but the EU has an opportunity to put an end to tax dodging and to take the lead in supporting developing countries by mobilizing much needed tax revenue and domestic resources for poverty eradication.