Heightened scrutiny by policymakers, media and public interest groups around the tax affairs of multinational corporations (MNCs) after the 2008 financial crisis arguably led to the biggest disruption to the international tax landscape in the last century.
The intense focus sparked a debate over whether MNCs pay a fair share of taxes in the countries in which they do business and eventually coalesced into the base erosion and profit shifting (BEPS) initiative led by the G20 and the Organisation for Economic Co-operation and Development.
“Corporate taxation has been under an intense and sustained public relations spotlight for the last several years, and our survey shows that businesses are responding accordingly to dim the glare.“
The 15-point BEPS Action Plan recommended changes to long-standing definitions, rules and practices, new reporting and compliance requirements and greater cooperation among tax authorities. Simultaneously, tax administration and enforcement became more assertive.
Both developments have fundamentally changed the tax authority-taxpayer dynamic and prompted many businesses to rethink how tax decisions will affect their reputation, brand and communication with internal and external stakeholders.
In this new environment, it is critical that businesses have a cohesive approach to tax risk and controversy management. The BEPS initiative has given tax authorities new tools to combat perceived abusive tax structures and emboldened them to be more aggressive in challenging tax positions.
As governments continue to implement the BEPS action items at varying speeds (and in sometimes inconsistent ways), and with tax authorities developing more sophisticated ways to obtain taxpayer data and enforce tax compliance, the international tax climate is likely to remain volatile for at least the next several years.
This, in turn, means that businesses should expect to see more audits, more tax controversies and a higher possibility of double taxation. Given this more-encompassing tax environment, it is evident that businesses are, in general, taking a more proactive approach to managing tax risk and controversy and are implementing more robust tax compliance processes.
In our 2017 Tax Risk and Controversy Survey, more than half (55%) of the 901 tax and finance executives in 69 jurisdictions who participated said that tax controversy management has become somewhat or significantly more important for their business in the past two years. Among large businesses (i.e., global businesses with more than US$3 billion in annual revenues), that number jumps to 64%.
Navigating a changing landscape
In a post-BEPS world, businesses must confront a constantly evolving — and sometimes hostile — tax climate. As governments continue to implement the BEPS recommendations, changes to local laws and regulations are being proposed or enacted around the world almost daily.
The steady stream of legislative and administrative changes is putting pressure on businesses to not only have effective protocols in place to monitor ongoing developments in their countries of operation, but also to have the right people, processes and systems to implement new government requirements and account for any differences in local laws and regulations.
The explosion of reporting and disclosure measures enacted in the last several years is also exposing businesses to new operational and reputation risks, as they must consider both the practical challenges of gathering and reporting the necessary data as well as the possibility that their tax information could be disclosed through the wider public through illegal leaks, voluntary public disclosure initiatives adopted by some countries, or mandatory public country-by-country reporting mechanisms that are being considered by some policymakers.
The rapid digitalization of tax administration and tax authorities’ increasingly aggressive enforcement approach are creating further challenges for businesses.
Ripple effects on the broader business
With so much on the line — from media scrutiny and “naming and shaming” (by official and unofficial means) to penalties, litigation and criminal liability — businesses can no longer afford to focus only on how tax decisions affect their bottom line.
Indeed, tax strategy and corporate reputation are now considered by many to be inextricably linked. Businesses must consider not only whether their tax decisions will meet globally agreed coherence and substance standards, but also be deemed fair and acceptable by multiple stakeholders, such as tax advocacy groups, the media and the general public.
Businesses are reconfiguring their operating models to align with the new global tax mindset, says Mat Mealey, EY EMEIA International Tax Services Leader at Ernst & Young LLP. “They’re now focusing more on locating profits with substance and taking advantage of tax rates,” he said.
More caution from businesses
While proactive management of effective tax rates remains a key objective for many global businesses, minimizing tax risk and protecting business reputation has become an urgent priority in today’s tax environment.
“Businesses are now looking at a range of factors when evaluating approaches to tax planning,” Mealey said. More taxpayers are asking all three of the following questions, rather than just the first:
- Is an approach legally effective, and do the benefits outweigh the costs of execution and defense?
- Is the proposal aligned with the intent and purpose of the legislation?
- Could I justify the outcome in a public forum?
However, whether the heightened tax risk climate is prompting businesses to be more cautious in their tax planning seems to vary dramatically.
Strategically addressing risk
The results of our survey indicate that businesses are putting in place various processes and tools to manage their tax risks. More than two-thirds of all respondents (68%) said they have complete, substantial or partial visibility over active tax disputes around the world. Among large businesses, that figure jumps to 81%.
More than half of all respondents said they have made changes (some, minor or significant) to their tax controversy policies over the past two years, while 4% said they have completely revised their policies or created a set of policies where none previously existed.
As for the reasons behind making those changes, the increased focus on the taxation of MNCs was the most-selected response, followed by an increased awareness of and sensitivity to reputational risks and increased transparency requirements.
Reservations about cooperative compliance
The rapidly evolving legislative and regulatory landscape, increasing demands for data and aggressive enforcement efforts have no doubt increased the number of tax disputes, which in turn has put more pressure on taxpayers and tax authorities to find better ways of preventing controversy and, if it cannot be avoided, developing more effective and efficient dispute resolution mechanisms.
In recent years, the OECD has touted cooperative compliance programs as an effective way to build trust and transparency between tax administrations and businesses. However, our survey results suggest that businesses, in general, have some reservations about forging more “open” relationships with tax authorities, although attitudes vary by country.
Use of APAs and MAP
Despite the surge in tax audits and cross-border disputes, the use of advance pricing agreements (APAs) and mutual agreement procedures (MAP) did not change dramatically in the last two years. Given the time and costs involved in obtaining an APA, it’s not surprising that only a relatively small percentage of survey respondents used APAs and that advance rulings were more frequently used.
With transfer pricing and related issues such as permanent establishments coming under increasingly intense scrutiny, however, APAs will likely become a more desirable option for mitigating tax controversy. Any changes in the use of MAP likely won’t happen for another couple of years.
Businesses need to take steps to prevent controversy while at the same time be prepared to manage and resolve disputes that do inevitably arise. We recommend three action steps: prevent, manage and resolve tax controversy.
1: Prevent tax controversy
Stop controversy before it occurs with top-down governance, systems and processes that enhance monitoring and compliance. An effective tax risk operating model should enable businesses to identify the tax risks in all of the jurisdictions in which they operate.
To maintain global consistency, businesses should have in place a documented tax strategy setting out the business’s approach to compliance, planning and interactions with tax administrations.
In light of the BEPS reforms and tax authorities’ increased enforcement efforts, businesses should revisit their transfer pricing documentation and defense files, as well as reevaluate tax provisions to reflect retroactive risks that might arise from aggressive inquiries and the dynamic approach taken by most countries to interpreting the BEPS amendments to the OECD Transfer Pricing Guidelines.
2: Manage tax controversy
Businesses should have tools and processes in place that allow them to manage ongoing and potential tax controversies at a global, strategic level. Implementing a global compliance and reporting framework can help businesses track and manage controversy by providing a multi-jurisdictional overview of controversy in a centralized repository.
To increase oversight, businesses should consider adopting a tax corporate governance framework, which formally documents a business’s policies and procedures and provides for an overview of tax risks by senior management and/or the board.
3: Resolve tax controversy
Businesses should develop a plan that sets out the circumstances under which disputes will be resolved, litigated or otherwise handled, which will help allow for faster resolution so businesses can resume focus on their core mission.
Businesses should evaluate the pros and cons of various dispute resolution mechanism (appeals, mediation, arbitration, litigation and MAP) and strive to build better relationships with tax authorities.
Adapting to the new environment
Corporate taxation has been under an intense and sustained public relations spotlight for the last several years, and our survey shows that businesses are responding accordingly to dim the glare.
Rapid advances in technology and unprecedented leaps and multilateral cooperation among tax authorities have fundamentally and permanently altered the rules of engagement. Businesses’ best approach is to prevent controversy in the first place. However, it is inevitable that some disputes will arise, so having processes in place to contain and efficiently resolve them will be critical.
In this new tax risk environment, being proactive is the best defense for businesses that seek to limit uncertainty and minimize the potential for significant controversy.
Read more: www.ey.com/taxriskseries