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Why double taxation is now a real concern

Tax directors at multinational companies must think more broadly about potential risks and gain access to the relevant information sooner.

By Rob Hanson, EY Global Director — Tax Controversy

How do we know what we don’t know?

It’s a deceptively simple question, and one that tax directors of multinational businesses are grappling with today in the face of constant change.

On a recent trip to Asia, for example, I met with the tax director of a multinational business who was concerned about a recent tax resolution in Europe.

The organization’s local employees had informed her at the last minute about a successful settlement (seeking her approval after the resolution had already been negotiated with the tax authorities).

“The tax director at a multinational company must now think more broadly and pro-actively about potential risks, and have access to the relevant information sooner.“

She was now trying to determine the possible repercussions in other European countries and around the globe.

She is right to be concerned.

In today’s interconnected tax world, where tax authorities increasingly share information, a tax ruling or resolution in one part of the world — in this case Europe — can be expected to have consequences for a company’s operations elsewhere.

Greater transparency is in itself a good thing.

But with it comes increased uncertainty for taxpayers.

Playing a new hand

Globalization, international tax reform and digitalization have transformed the tax field in recent years.

Taxpayers must develop new strategies to cope with today’s reality.

It’s a significant challenge when you consider the many different developments occurring simultaneously — each with unique challenges.

In the past, even recently, organizations did not plan extensively for controversy.

Businesses filed their tax returns and dealt with any questions or concerns from tax authorities a few years later — more often than not in an amicable way.

Governments today, however, are under pressure to gather more tax revenue and are overhauling their approach to tax collection.

Tax authorities are more focused than ever on collecting what they believe is the right amount of tax.

In this environment, controversy is no longer a case of if, but when.

The BEPS effect

A significant catalyst for change is the base erosion and profit shifting (BEPS) project by the Organisation for Economic Co-operation and Development (OECD).

The BEPS reforms are expected to lead to greater transparency and increased certainty in the long term.

But as the various initiatives are rolled out across the world, there could be greater tax controversy in the short to medium term until any inconsistencies are resolved.

One of the recommendations requires multinational businesses with more than €750 million in revenue to file reports with financial and tax information for every tax jurisdiction where they do business.

Tax authorities can exchange this information through different mechanisms, including bilateral tax conventions.

The goal is to provide tax authorities with comprehensive information about where profit, sales, employees and assets are located and taxes paid.

Not as simple as it seems

If everyone has access to the same information, it should be easier to determine the correct amount of taxes owed.

However, each country has its own tax laws and may not view a transaction or structure the same way.

We are seeing the consequences of such diverging viewpoints in Europe.

A number of multinational businesses have found themselves the target of European Commission State aid investigations in recent years.

These probes are focused on whether tax benefits granted to these organizations by sovereign nations were in fact not accepted under European Union rules.

The investigations are retroactive — in some cases going back a decade or more — and billions are at stake as a result of conflicting perspectives.

The organizations involved must also deal with the reputational risk stemming from such actions.

Double trouble

Digitalization presents another considerable risk for tax departments today.

Tax authorities around the world are digitally gathering, storing and analyzing tax data, and sharing this information with each other.

The expanding web of information is incredibly complex.

Companies often have different business lines, units and supply chains and operate in multiple jurisdictions.

As taxpayers submit increasing amounts of information, it could alter their tax picture depending on how the tax authority analyzes and reviews that data.

In this environment of rising uncertainty, double taxation has become a tangible threat for taxpayers.

When cross-border tax disputes arise, the countries involved may all insist they are owed more money.

There is little downside to a government trying to collect more tax revenue.

But uncertainty and inconsistency are not good for business.

In a September meeting in Shanghai, the G20 countries publicly supported the OECD’s efforts to reinforce certainty throughout the global tax system, acknowledging the “benefits of tax certainty to promote investment and trade.”

Supporting certainty

Tax administrations have developed new ways to better enforce their laws and have been sharing more information, but there is still progress to be made on the resolution of multi-jurisdictional disputes.

On this front, there is still much work to be done by local tax authorities, and regional and supranational organizations.

The BEPS reforms do include measures aimed at improving dispute resolution mechanisms.

One goal is to increase the effectiveness of the mutual agreement procedure (MAP), a feature of tax treaties that permits so-called competent authorities from governments to resolve disputes, including double taxation.

A peer review process will monitor whether countries are adhering to the new MAP guidelines.

Governments’ commitment to the revised MAP process will ultimately determine whether it is a success.

It will be a long and challenging process, and countries will need to devote sufficient resources, including people, to develop a robust conflict resolution process.

Governments must also provide clarity to taxpayers on their legal positions with regard to complex matters, such as transfer pricing, hybrid instruments and debt equity issues.

Taking action

While much of this is out of taxpayers’ hands, businesses can still take measures to reduce uncertainty. Greater information sharing and the introduction of MAP are forcing organizations to take a forward-looking approach to controversy.

The tax director at a multinational company must now think more broadly and proactively about potential risks, and have access to the relevant information sooner.

This brings us back to the tax director in Asia who was concerned about a ruling in Europe.

How can companies stay on top of all these risks, especially when none have tax employees in every country where they operate?

Organizations can start by defining their baseline.

What are the company’s risks around the world, and what kind of internal processes and controls are already in place?

The next step would be to set up or strengthen the system that monitors global risks.

It takes time and may be costly, but so are tax controversies with hundreds of millions at stake.

Of course, businesses would prefer to invest their money in developing new products and services.

But tax directors, the C-suite and the board should see these changes as an opportunity.

They can set up the tax function of the future, which is strategically aligned with the rest of the business and equipped for a digital future.

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EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.

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