By Gerri Chanel
In the post-BEPS world, the presumption of innocence does not always extend to multinational companies when it comes to their tax affairs.
Tim McDonald, Vice President — Finance & Accounting, Global Taxes, for consumer goods giant Procter & Gamble, says the nature and intensity of audits have dramatically increased in recent years.
“There’s now a presumption that you’re not operating correctly and that you’re violating law even before individual facts are introduced, and there’s a presumption that there’s significant revenue to be raised,” says McDonald.
Adding to the scrutiny at times, he says, is a view that “if country A is being aggressive, country B doesn’t want to be left behind.”
“The pressure of doing something about base erosion and profit shifting was not created by the OECD BEPS project, and the alternative scenario would have been countries going off and completely doing their own thing.“
Achim Pross, Head of the International Co-operation and Tax Administration Division at the OECD Centre for Tax Policy and Administration
When the Paris-based Organisation for Economic Co-operation and Development (OECD) launched its base erosion and profit shifting (BEPS) project in 2013, a convergence of trends had already created the harshest controversy environment in years.
More frequent robust audits, increasing disclosure and transparency requirements, and constantly changing tax legislation, among other developments — were causing unprecedented tax risk and uncertainty.
Today, these dynamics have escalated and new ones have blossomed, tax professionals say.
As businesses and governments navigate the new tax environment, the stage looks set for even higher levels of tax controversy and uncertainty for the foreseeable future.
The OECD’s approach to curtail BEPS was meant to be a phased, unified implementation.
Such order has proved elusive.
It is still not clear if, when and to what extent individual jurisdictions will adopt the OECD recommendations in their legislation and tax treaties.
In addition, the project itself is still evolving.
Ongoing changes and inconsistency and uncertainty over how to treat them are likely to result in sustained and significant levels of controversy.
“We haven’t seen how some countries will use BEPS,” says Heather Maloy, US Tax Controversy Leader, EY National Tax, based in Washington, DC. “And we haven’t seen whether there will be a backlash to it.”
Ambiguity also arises from separate independent initiatives, such as the UK’s diverted profits tax.
In response to the UK legislation, Pascal Saint-Amans, Director of the OECD’s Centre for Tax Policy and Administration, commented in 2014 that ‘‘it’s a bit bizarre that in the middle of the project, you have a country acting unilaterally because that’s what we’re trying to avoid.’’
The UK is not alone.
Australia enacted a multinational anti-avoidance law and has proposed a diverted profits tax expected to take effect in mid-2017.
Together, they are similar to the UK’s diverted profits tax, but operate more stringently and impose greater sanctions.
And, of course, US President Donald Trump’s tax reform proposals will potentially ripple through the global economy, forcing governments and taxpayers to consider how they will interact with BEPS-related changes.
Countries are acting unilaterally for a variety of reasons.
They may view the solution to cross-border base erosion differently than the OECD recommendations or may be seeking broader solutions.
“International tax rules to mitigate BEPS in the strictest sense addresses cross-border transactions, but General Anti-Avoidance Rules (GAAR) apply to all taxpayers,” says Balaji Balasubramanian, Singapore-based Senior Tax Manager, Financial Markets — Fixed Income, for Standard Chartered Bank, which operates in more than 70 countries.
The diverted profits tax proposed in Australia and implemented in the UK is an example of targeted measures adopted by tax authorities, whereas GAAR, enacted in China and soon to be implemented in India, applies to a broader range of transactions, according to Balasubramanian.
In cases where BEPS provisions are adopted by jurisdictions that already have GAAR or specific anti-avoidance provisions (tax laws designed to deal with particular transactions), clarification may be needed to address potential conflicts.
Regional initiatives are producing additional complexity and uncertainty.
Consider the European Union’s State aid regulations, which allow the European Commission to overturn any ruling or benefit from an EU Member State that gives a business, industry or regional group of companies a selective advantage that could distort trade between member states.
The EU State aid regulation has been in effect for years and applies to any type of advantage, including tax benefits.
Historically, there have been few large-scale State aid tax investigations.
But in recent years, an unprecedented number of investigations have been launched with large amounts at stake.
In August 2016, for example, the European Commission rendered its decision following an investigation into alleged State aid issues associated with tax arrangements of a US multinational with the Irish Government.
Ireland has now been ordered to recover unpaid taxes by the business for the years 2003 to 2014 of up to €13 billion, plus interest.
Both the Irish Government and the company have announced they have appealed the ruling.
In an October 2016 EY survey of senior tax executives, 23% said they are currently under audit in more than 15 countries, an increase of 6% from 2015 and 10% from 2014.
In line with this, 56% said the number of countries subject to an active audit has increased, up by seven points from 2015.
“We are seeing multinationals encounter more aggressive audits in an increasing number of jurisdictions. In some cases, the number of open years under audit has doubled in the last five years,” says Rob Hanson, EY’s Global Director of Tax Controversy, based in Washington, DC.
Audits have also become more adversarial.
In the same survey, 72% of respondents said the enforcement posture and tactics of foreign tax authorities had become more aggressive, up from 66% in 2015.
“Since OECD member states have until 2019 to implement the BEPS provisions, it is a bit too early to see what controversy will arise directly from it, but we are already seeing in many conferences with tax authorities that their mindset has changed and that they feel stronger in their positions,” says Klaus von Brocke, the Munich-based leader of EY’s EU tax services group.
In the next two years, which areas do you expect to be the most important areas of controversy with regard to tax?
Respondents anticipate using more advance pricing agreements in the post BEPS environment.
The proportion of survey respondents identifying “tax risk management” as their top priority has grown over the last decade
Satisfaction levels with competent authority process.
Focused on BEPS
In addition to a more adversarial stance by authorities, almost half of respondents to the EY survey reported that tax authorities are raising audit issues that reflect BEPS focus areas, a jump of 16% over 2015.
McDonald’s experience supports this trend: “We’ve seen a number of governments cite BEPS as authority in their audit behavior based on their existing laws when in most cases countries need to pass new laws that reflect the OECD guidance.
“They therefore require treaty ratification, either through the multilateral instrument or through bilateral treaty negotiation,” McDonald says. “That has not stopped governments from claiming authority under BEPS and taking robust new positions.”
Tax administrations that in the past worked alone on tax issues are now increasingly working with justice departments and courts, according to Jean-Pierre Lieb, Paris-based Leader of the EMEIA Tax Policy and Tax Controversy teams for EY Société d’Avocats.
“Tax administrations are also less reluctant than in the past to use criminal penalties to challenge companies,” Lieb says. “We have seen this happening in Italy, Spain, France, the UK and Germany.”
“Some jurisdictions are using tax police to enforce criminal penalties,” adds Hanson, “which could lead to tax raids and arrests. The result is that senior executives traveling into the local country from headquarters are potentially at risk of being detained and accused of criminal wrongdoing.”
While cross-border information sharing is not new, it only began to gain significant traction in 2009 amid OECD pressure to crack down on tax havens and bank secrecy, along with the reorganization of the OECD Global Forum on Transparency and Exchange of Information for Tax Purposes.
And the pace has continued to accelerate.
During the past five years, the number of agreements for information exchange upon request has doubled, from about 3,500 to 7,000.
“The level of experience and expertise around data mining and data analysis is also different from one tax administration to another. As a result, not all authorities have the same capabilities to adapt to all the new information.“
Jean-Pierre Lieb, Paris-based Leader of the EMEIA Tax Policy and Tax Controversy teams for EY Société d’Avocats.
The first multinational automatic information exchange program, the EU Savings Directive, dates to 2003 (it was later replaced by a broader provision), but action accelerated after the 2010 enactment of the Foreign Account Tax Compliance Act (FATCA) by the US.
The G20 then sought a global standard for automatic exchange of certain financial information and endorsed a common reporting standard (CRS) developed by the OECD in 2014.
Currently, more than 100 jurisdictions have committed to implement the CRS, under which financial institutions will report specified information to the residence jurisdiction of taxpayers.
The first automatic exchanges under the program begins in 2017 and will accelerate in 2018.
‘A lot more information’
This year will be a watershed one for another reason.
A number of countries have already adopted the country-by-country reporting (CbCR) requirement recommended by the OECD and some of those filings will begin in 2017.
Automatic exchange of the information is also a foregone conclusion: as of late 2016, 50 jurisdictions had signed agreements providing for the automatic exchange of CbC reports and that is expected to be only the beginning.
The new automatic exchange programs will increase the amount of information available to tax administrations regarding the assets and cross-border activities of both individuals and entities.
“Administrators will have a lot more information,” says Maloy. “What are they going to do with all that information?”
One concern is that information may be misinterpreted without the right context.
Because CbC data is high-level, it is particularly subject to misinterpretation.
For example, if a company has very different businesses in different countries, comparison across countries might be meaningless.
Auditors may not seek the correct context before proposing tax adjustments, especially if they are short-staffed, and some, especially in the current environment, might be more likely to take a hard line about their position.
The HR and analytic capabilities of tax administrations are also diverse and in flux.
While there has been a spike in transfer pricing resources within many tax administrations, leading to more tax inquiries and audits, many tax administrations have reduced their staff due to budget restrictions.
“The level of experience and expertise around data mining and data analysis is also different from one tax administration to another,” says Lieb. “As a result, not all authorities have the same capabilities to adapt to all the new information.”
Here to stay
Even when BEPS legislation is fully implemented, uncertainty will remain since the recommendations reflect a move away from relatively clear rules and well-understood standards to more subjective tests and alternative approaches.
A number of the new rules will be more challenging for taxpayers to apply and for tax authorities to administer.
However, Achim Pross, Head of the International Co-operation and Tax Administration division of the OECD’s Centre for Tax Policy and Administration, points out a perspective that is sometimes overlooked during the current upheaval.
“The pressure of doing something about base erosion and profit shifting was not created by the OECD BEPS project, and the alternative scenario would have been countries going off and completely doing their own thing,” says Pross.
“The structured and coordinated BEPS project, with its stakeholder involvement, committees and technical discussions with everybody around the table has achieved much more certainty than there otherwise would have been.”
Searching for certainty
Efforts to enhance certainty are now underway.
At the EY aHead of Tax event in June 2016, Saint-Amans gave a preview of a host of practical actions on the OECD’s agenda to improve certainty.
For example, he said the OECD will try to get as many countries as possible to commit to binding arbitration in mutual agreement procedure (MAP) cases. Taxpayers would have more certainty if they know treaty-related disputes will be resolved through MAP.
Saint-Amans also said he hopes countries will start signing a multilateral instrument to implement tax treaty-related BEPS measures in the first half of 2017 during the German G20 Presidency.
Along with promoting the value of advance pricing agreements (APAs), “the OECD Forum on Tax Administration will continue to promote the value of cooperative compliance between revenue bodies and large business taxpayers,” Saint-Amans said.
Amid this environment of transformation, governments understand they must provide some degree of certainty to taxpayers.
In July 2016, the G20 finance ministers signaled a priority to promote economic growth and acknowledged the importance of tax certainty in promoting that growth through investment and trade.
At the meeting of the G20 leaders in September 2016, the roles of taxation and tax certainty were key agenda items.
At the summit, the OECD and the International Monetary Fund (IMF) were asked to continue working on pro-growth tax policies and tax certainty.
Pursuant to that mandate, the OECD launched a survey in October inviting businesses and other stakeholders to contribute their views on tax certainty, including what they consider the main sources of that uncertainty and their preferred solutions.
The survey results will be included in an OECD report to G20 leaders in advance of their 2017 summit, setting out practical and concrete policy options to enhance certainty.
Oddly, the G20’s focus on boosting economic growth through tax could usher in another era of tax reform — and another wave of uncertainty.
“A convergence of many realities came together to produce the BEPS project,” says McDonald. “Many of those pressures are still with us and they are likely to remain for some time — it’s our new reality.”
Key action points
- Develop a consistent philosophy of controversy: under what circumstances will disputes be resolved, litigated or otherwise handled?
- Evaluate resources, processes and systems for global tax risk identification and management, including the ability to stay connected with complex, voluminous and fast-paced change
- Make certain the board and audit committee understand and agree with the corporate policies for tax risk and tax controversy and understand the structure and key processes for the organization’s tax controversy and risk management