by Rob Hanson, EY Global Tax Controversy Leader, Alex Postma, former EY Global International Tax Services Leader, Frank Ng, Ernst & Young LLP Executive Director Tax Controversy and David Canale, EY Global Transfer Pricing and Controversy Services Leader
A U.S. multinational corporation (MNC) with a principal structure in Europe was being audited by one European Union (EU) country’s tax authority regarding its limited risk distributor (LRD) structure. Three months later, another EU country’s tax authority opened up an audit asking the same questions and requesting the exact same tax adjustment that the first country’s tax administrators had requested. Coincidence? Not likely. One tax administration had shared its audit information with the other before the earlier audit was even complete.
In another example, a U.S. MNC set up a principal structure and cost-sharing arrangement in Europe almost two decades ago, at which time the IRS audited and approved the arrangement. Recently, to gain greater tax certainty in the face of the U.K.’s diverted profits tax (DPT), the corporation sought a bilateral advance pricing agreement (APA) between the U.K. and another non-U.S. principal country for transfer prices related to its LRD structure to avoid a DPT characterization of the U.K. LRD. Three months later, the IRS initiated a new audit on the U.S. parent company related to its cost-sharing arrangement; the audit was based on information obtained from the company’s APA submission to the U.K.
Global tax environment
Welcome to the interconnected global tax environment, where information provided to one tax jurisdiction will likely be available to others in short order.
MNCs need to be aware of this level of information sharing and understand that the actions they undertake in one country could potentially impact their situation in other countries as well. Aggressive tax enforcement and greater audit scrutiny of cross-border transactions have become more commonplace in recent years, as the Organisation for Economic Co-operation and Development (OECD), the EU, and individual tax authorities collaborate and share information on companies’ tax profiles and cross-border transactions.
The volume of regulations and new tax laws is increasing, driven by the global focus on base erosion and profit shifting (BEPS). What is new is the speed with which tax information is being shared and the broad reach of the flow of information.
Taxpayer information can now be quickly cross-referenced and shared among governments and agencies with a few clicks, making consistency a critical part of any company’s tax risk management strategy. Tax authorities are also “reaching back” and reexamining prior transactions through today’s lens, challenging previously established norms and structures. As such, the effective impact of more aggressive tax administration is retrospective. A very visible example of that are the EU state aid investigations, with 10-year retrospective liabilities arising on tax rulings that might have been considered routine and secure at the time they were granted.1
Moving at the speed of digital
Global tax authorities’ increasing use of digital methods to collect and analyze taxpayer data is adding to the challenges. Businesses are increasingly being asked to electronically submit a variety of data that goes beyond tax records, in formats specified by the government and on an accelerated schedule. Tax authorities use data analytics engines to find any discrepancies and compare data across jurisdictions and taxpayers, and make tax and audit assessments based on these analyses.
Businesses are often unable to keep pace with or match the digital technologies some tax administrations are using, resulting in less “polished”— and potentially less consistent — data submissions than in the days when they had time to perform multiple quality checks.
In this new transparent tax world, having outdated processes can add exponentially to the risk of more inquiries, penalties and disagreements with tax authorities. In fact, respondents to our 2017 Tax Risk and Controversy Survey Series identified a lack of processes or technology as the second-most influential source of an increased level of tax risk and controversy for their company (second only to the increase in the volume and/or complexity of tax legislation and regulations).2
Compliance is further complicated by data submission requirements that can vary by country, not only in file format and timing for submissions, but also in the scope of taxes or transactions covered. In some cases, revenue authorities in emerging and developing countries are trailblazers in digital tax administration, adding to the risks businesses face through dated systems that can prevent them from being able to adapt quickly. (Of the top 10 jurisdictions our survey respondents cited for the greatest tax risk in the next 2 years, 4 were emerging economies, with China ranked second, India fifth, Brazil seventh, and Mexico ninth.)
Businesses need to have the right people, processes and technology enablers in place that account for and manage these often disparate digital requirements. They seem, however, to be adjusting slowly to this new reality. Some 36% of total respondents to our survey (47% of large business respondents) said they leave monitoring and responding to new country-level digital requirements to their local or regional finance personnel, and 15% of respondents (17% of large business respondents) said they were not sure what efforts were being made within their company to address digital changes across countries.3
Businesses lacking an enterprise digital tax administration strategy with sustainable processes will face greater tax uncertainty and risk as revenue authorities accelerate their pace of development and implementation of new digital tax provisions.
From bilateral to multilateral
Consistency is also vital in a global tax environment that continues to shift from bilateral relationships to multilateral ones in terms of information sharing, risk and tax controversy resolution. An example can be seen in the growth of country-by-country (CbC) reporting. All 102 countries that signed onto the OECD’s BEPS-inclusive framework have committed to implementing CbC reporting, and the OECD continues to release periodic guidance in response to practical questions that have come up. In this way, CbC reporting continues to evolve, and businesses need to closely monitor new or amended reporting requirements, strive for consistency in their submissions, and reflect any changes in their global risk management procedures.
In addition, the forthcoming adoption and implementation of the EU directive on mandatory disclosure will require intermediaries (advisors) to disclose and report certain types of cross-border arrangements within the EU and between EU member states and non-EU countries.4
The reporting shifts to the taxpayers where there is no intermediary involved or the intermediary has no EU-nexus. This new reporting will be automatically exchanged within the EU to provide tax authorities with greater transparency of cross-border transactions for EU businesses. This is another example of the continuing multilateral efforts to monitor tax planning for cross-border transactions.
Businesses are also seeing a significant change in how countries are viewing companies’ use of and reliance on tax treaties. The OECD’s Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS, known as the multilateral instrument (MLI), now has enough countries on board to “go live,” with the first treaties affected by January 1, 2019. The MLI is designed to allow countries to efficiently update the world’s 3,400 double tax treaties to take into account BEPS changes.
Changes potentially adopted via the MLI will have significant implications for businesses. The MLI mandates that all signatories introduce a principal purpose test, for example, and allows the option of a simplified limitation of benefits provision to curb treaty abuse. This could mean many countries may soon deny treaty benefits when obtaining a tax benefit was a principal purpose of the business’s arrangement.
Given the potentially large changes in policy the MLI could bring, businesses need to examine the potential effect on issues such as capital gains and future reorganizations and determine where they are relying on treaty relief. Businesses also need to put consistent processes in place to evaluate the MLI’s effect on their treaty reliance across the jurisdictions in which they operate.5
The shift from bilateral to multilateral is also evident in the programs being promoted as options to provide taxpayers with greater tax certainty. In January, the OECD launched the International Compliance Assurance Programme (ICAP) pilot, a voluntary program that will rely on CbC reports and other taxpayer-provided information. In return for transparency and open discussion of their tax risks, businesses ideally receive an outcome letter and some assurance that they will not receive further compliance interventions from the tax administrations covered by the program. A successful ICAP outcome may well provide MNCs a level of certainty to their CbC reporting with potential global benefits to their global tax risk profile, especially for MNCs currently participating in some type of cooperative tax compliance or tax control framework program.
A global approach to tax risk management
In a world of such rapid change, businesses that are struggling to know who has their data and what they are doing with it can easily lose control of their own tax narrative. To regain control, it is helpful to examine the areas that are likely to be the source of the greatest risk and begin to develop a proactive and globally consistent tax controversy management and risk strategy.
MNCs need to know where their information is, who handles it, who has access to it and who their external advisors are. Managing global controversy risk from the center is key. This may be a new paradigm for businesses that have grown through acquisitions and are used to managing tax risk in a decentralized way through their local teams.
As tax administration becomes ever more interconnected, the pace of change in tax is likely to accelerate further, creating more controversy risk. Digital tax administration will spread farther, formal and informal information sharing will increase, and multilateral programs for shaping treaties and resolving disputes will continue to evolve.
Businesses that shift their mindset to address these issues proactively in a consistent and strategic way will be better equipped to manage controversies as they arise. Specific steps businesses can take to adopt a more consistent global approach to tax controversy management include:
- Implement a documented tax strategy setting out a consistent approach to compliance, planning and interactions with tax administrations.
- Adopt a tax corporate governance framework that formally documents the business’s policies and procedures and provides senior management and/or the board oversight of tax risks.
- Put tools and processes in place to consistently manage ongoing and potential tax controversies at a global, strategic level. A global compliance and reporting framework can help track and manage controversy by providing a multi-jurisdictional overview of controversy in a centralized repository. It can also alert to potential impacts a tax controversy resolution in one jurisdiction could have across the businesses’ global tax footprint — particularly as tax authorities increasingly share this information among themselves.
- Develop a plan that sets out the circumstances under which disputes will be resolved, litigated or otherwise handled.
- Evaluate the pros and cons of various dispute resolution mechanisms (appeals, mediation, arbitration, litigation and MAP) and strive to build better relationships with tax authorities.
Reproduced with permission from Copyright 2018 The Bureau of National Affairs, Inc. (800-372-1033) www.bna.com
1 “Dimming the Glare,” EY 2017 Tax Risk and Controversy Series, https://go.ey.com/2EoJoz6.
2 “Finding your glow: how businesses can optimize their tax function,” EY 2017 Tax Risk and Controversy Survey series, http://www.ey.com/Publication/vwLUAssets/ey-finding-the-glow-optimizing-the-tax-function/$FILE/ey-finding-the-glow-optimizing-the-tax-function.pdf
4 “Council of the EU reaches an agreement on new mandatory transparency rules for intermediaries and taxpayers,” EY Global Tax Alert, 14 March 2018, http://www.ey.com/Publication/vwLUAssets/Council_of_the_EU_reaches_an_agreement_on_new_mandatory_transparency_rules_for_intermediaries_and_taxpayers/$FILE/2018G_01508-181Gbl_EU - Agreement on new mandatory transparency rules.pdf.
5 “Tax treaties are at a crossroads,” EY Tax Insights, http://taxinsights.ey.com/archive/archive-articles/leading-insight--tax-treaties-are-at-a-crossroads.aspx.