Taxpayers and tax authorities alike agree that their world is suddenly rife with uncertainty and that the risks associated with that uncertainty are on the rise.
Tax reform in the US, in particularly, is causing businesses around the world to re-evaluate structures and supply chains and causing foreign governments to assess the impact on their tax base. This effort comes even as both work to understand and implement recommendations to prevent base erosion and profit shifting (BEPS) made by the Organisation for Economic Co-operation and Development (OECD)
"If taxpayers don’t understand what authorities are most worried about, they might encounter controversy where they aren’t expecting it."
Gijsbert Bulk, EY Global Director of Indirect Tax
Both taxpayers and tax administrators agree that the potential for tax controversy is on the rise, and avenues to settle these disputes are not optimal. This much is clear from our separate surveys of taxpayers and tax authorities in 2017.
But they don’t agree on everything — taxpayers and tax administrators have different concerns and objectives and don’t prioritize the same risks. And administrators from different countries diverge in their concerns as well.
Until the current transition period gives way to a more predictable system for tax administration, multinationals seem destined to struggle to avoid conflict that results in incidences of double taxation or more. The drivers of controversy will become more apparent with time. Among them are:
- More transparency, particularly around transfer pricing
- More aggressive audits
- Taxation of intellectual property
- Efficacy of multilateral alternative dispute resolution programs such as advance pricing agreements (APAs) and cooperative compliance programs
The riskier environment is also prompting leading businesses to refocus their approach to global tax controversy management, even as they struggle to secure and deploy the resources necessary to comply with a rapidly changing digital tax environment. Many tax authorities are developing more sophisticated capabilities to collect and analyze large volumes of data and have made great strides in recent years to share information on a more routine basis.
This means more real-time auditing, more demands for information from taxpayers and less time for taxpayers to respond to these demands. Many taxpayers, by contrast, are struggling to keep up and obtain the resources they need to fully engage with government requirements.
The increasingly sophisticated capabilities of tax authorities mean “executives need to have a strategic view and global approach to controversy management,” says Frank Ng, an executive director in our Tax Controversy and Risk Management Services.
Focusing on different risks
Taxpayers in our global 2017-18 Tax Risk and Controversy Survey told us they perceive transfer pricing as their top source of risk, followed by indirect taxes. Tax authorities inverted those priorities: they ranked indirect taxes their highest compliance risk, followed by transfer pricing, broadly defined to include goods and services, intangibles and financial services. Taxation of the digital economy was a close third.
It stands to reason that tax authorities are so concerned about indirect taxes — they represent a growing share of tax revenue in many countries and currently are equal to about 13.6% of gross domestic product in the European Union. And business shouldn’t lose sight of that, even as they focus on adapting to tax reforms on the income tax side.
“The disconnect here between tax authorities and taxpayers has the potential to lead to more controversy, because there will be an inherent mismatch of resources and priorities,” said Gijsbert Bulk, our Global Director of Indirect Tax. “If taxpayers don’t understand what authorities are most worried about, they might encounter controversy where they aren’t expecting it.”
But even among tax authorities, there were split perceptions about sources of risk, and the divergence correlated strongly with the size of a country’s economy, with G20 countries perceiving things differently than those with smaller economies. Both ranked indirect taxes as their top compliance concern, but the proportion was more pronounced in non-G20 countries. By contrast, transfer pricing was also a bigger concern for G20 countries, with the digital economy ranking third.
Furthermore, taxation of the digital economy ranked second among non-G20 countries identifying their highest compliance risk. And no non-G-20 countries identified transfer pricing of goods and services or financial services as a top risk; few said transfer pricing of intangibles was their highest compliance risk.
Tax risk associated with the digital economy continues to be a main focus in the EU, which released a report on 1 March outlining a collective approach to correcting what it said is a “mismatch between where taxation of the profit takes place and where value is created for certain digital activities.”
Calls to action
Armed with this knowledge, companies now need to take steps to address these issues:
- Bring your technology up to date. With governments keen to address indirect tax and digital tax administration on the rise, it will be important to have information technology systems current and able to respond to requests from tax authorities in real time or near real time. It will also be important to know where your potential controversies fall on tax authorities’ priority lists. They will be less likely to allocate their scarce resources to unique problems, instead looking to challenge arrangements that could apply to many companies.
- Adopt a global approach to managing tax controversy. The transparency trend, and the potential for news stories to create reputational risk, suggests that tax controversies should no longer be left to local offices that best know their country’s tax authorities. These have the potential to be global problems, and a controversy with one country could quickly become a controversy with multiple countries. For that reason, a global approach is necessary.
- Take a strategic approach to dispute resolution programs as BEPS certainty grows. Neither taxpayers nor tax authorities are strong believers in the dispute resolution tools available to them, and that calls into question the basic trade-off for companies — certainty on tax questions in exchange for sharing more details about your business. All of these programs can be very effective tools, under the right circumstances, which means that companies will have to evaluate cooperative compliance programs, APAs and other alternatives on a case-by-case basis for fit and purpose.
- Monitor — and adapt quickly to — policy shifts and law changes around the world. The 2017 US tax reform was the biggest change in the world’s largest economy in 30 years. And companies that do business in the US are actively analyzing the impact on their operations. In addition to BEPS implementation around the world and the changes that will bring, many countries may react to the US law with tax reforms of their own. The current cycle of tax reform globally could fundamentally shift tax rules as we know them today, setting the stage for more uncertainty and controversy.
Read more: ey.com/taxriskseries
How we can help: Business Tax Services