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  • Service: Tax
  • Type: Business and industry issue
  • Date: 2/24/2014

Tax Disputes and Controversy Update – Focus on Horizontal Monitoring 

In a recent webcast, Sharon Katz-Pearlman led a panel discussion with six Tax Dispute Resolution and Controversy Services leaders from across KPMG International’s network of firms. Countries represented included four with established programs – Netherlands, United Kingdom, United States and Canada – and two that are currently piloting a horizontal monitoring program – Russia and France.1 A summary of this discussion follows, starting with Sharon Katz-Pearlman’s analysis of the webcast’s participant polling results.

How are these programs evolving? Are they meeting their objectives of easing compliance and allowing tax authorities to re-direct resources to taxpayers with higher non-compliance risk?


Global overview – Sharon Katz-Pearlman, Head of KPMG’s Global Tax Dispute Resolution and Controversy (GTDR&C) Services


Based on our poll of 721 corporate tax executives taking part in our recent webcast, large corporate taxpayers feel that they are operating in a volatile tax environment. Over 75 percent of respondents say that they are involved in a tax examination or dispute with a revenue authority, with 43 percent reporting they feel the process takes too long and is too expensive. A further 26 percent say the auditor(s) may lack the requisite technical skill to deal with some of the transactions and/or issues and 20 percent say that the audit may focus disproportionately on immaterial or insignificant issues. A small but notable 11 percent indicate the process is too adversarial.


With the majority of respondents also saying that they expect to see the same or increasing level of audit activity, corporate taxpayers may welcome the concept or use of a horizontal monitoring program by a tax authority. Under these programs, tax authorities take on a broader, real-time servicing role in exchange for large corporate taxpayers adopting a more open, interactive approach to their tax audits. By making the tax audit process more efficient and productive and less adversarial, a smaller number of disputes should potentially result.


While only 13 percent of respondents say they are currently involved in a horizontal-type monitoring program, the majority (80 percent) of those who are involved say their overall experience has been somewhat or very positive. Benefits of these program cited by respondents include:


  • reaching earlier certainty on tax issues (38 percent)
  • more efficient use of resources (30 percent)
  • limiting the focus of the audit to significant/material processes (23 percent).

As these programs continue to spread and build momentum globally, taxpayers will need to decide if they want to pursue them. Based on the poll, 21 percent of respondents say they would participate in a program if given the opportunity and 10 percent would not. The majority (39 percent) says that they are not sure if they would participate. This result shows the need for more detailed information about the various programs so taxpayers can make appropriate decisions for their specific situations.


As the following snapshots of horizontal monitoring programs in six countries show, these programs can truly enhance the ability to communicate with tax authorities. However, there is still work to be done. Education, clarification and confirmation of programs by tax authorities with their corporate taxpayers are essential.





Horizontal monitoring in the Netherlands – Dick Barmentlo, Attorney-at-law and tax adviser Tax Dispute Resolution & Controversy group KPMG Meijburg & Co.


The Dutch Tax Authorities (DTA) were first to take up horizontal monitoring with a pilot project in 2005 involving multinational and very large domestic enterprises. Since then, the program has expanded to cover almost all multinational corporate taxpayers in the Netherlands, with a smaller number of small and medium-sized corporate taxpayers taking part through intermediaries such as tax advisers and professional accounting organizations.


As with other horizontal monitoring programs, establishing mutual trust is critical to the success of the Dutch program. Tax authorities need to have confidence in the data supplied by taxpayers, and taxpayers have to demonstrate that their information can indeed be trusted. In part, this mutual trust is established through the negotiation of a formal covenant between the two parties. This formal covenant sets expectations regarding timeliness, transparency regarding taxpayers’ sharing of information (i.e. without being asked as the Dutch tax law would require outside the horizontal monitoring program), and the tax authority’s obligation to provide clarity and certainty on tax positions.


Following several years of largely successful operation, the horizontal monitoring program underwent an independent review in 2012. Many of the recommendations arising from the review called for more rigor in testing the effectiveness of tax control frameworks to determine how well taxpayers are equipped to manage their tax risks.


The year 2013 saw the introduction of new guidelines for large taxpayers under the horizontal monitoring program. Among other things, under the new guidelines taxpayers who push the boundaries of acceptable tax planning are not permitted to take part in the program. In practice, however, this particular guideline is problematic as there is little certainty over what planning the tax authority considers aggressive.


Under another 2013 guideline, the DTA are now directed to share their action plans with taxpayers, explaining how they will be treated for tax audit purposes. Random statistical sampling is now recognized as suitable for tax audit purposes. If the DTA are satisfied with the taxpayers’ sampling practices, the taxpayers’ self assessment will be accepted.


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Horizontal monitoring in the United Kingdom – Paul Harrison, Partner, Tax and Head of Settlements & Investigations, KPMG in the United Kingdom


The UK’s HM Customs & Revenue (HMRC), an active member of the OECD’s Forum on Tax Administration, established its equivalent of a horizontal monitoring program following a consultation in 2006 with large businesses; the Review of Links with Large Business. Recommendations from this review included providing greater certainty for taxpayers through improved advance rulings and extended clearance services, as well as better guidance on new legislation and more consultation with business. Quicker resolution of issues was also called for, especially in the area of transfer pricing.


Satisfying these recommendations required HMRC to use its resources more effectively. HMRC developed a new standardized process to formally assess business tax risk and established a High Risk Corporates Program in order to direct more resources to businesses with the greatest risk of non-compliance.


HMRC currently assesses this risk on the basis of the quality of taxpayer’s governance of tax, its tax filing record and tax accounting arrangements, and its approach to tax planning. Other factors that influence a large business’s risk assessment include its industry and level of complexity, the extent of its cross-border transactions, and degree of business change, (e.g. through mergers and acquisitions). Taxpayers assessed as low risk enjoy three years of minimal or no tax audit interventions.


A unique aspect of HMRC’s approach is the introduction of “customer relationship managers” (CRM) to manage the relationship between the business and HMRC across all taxes and duties. CRMs are charged with managing responses to the business’s queries, clearance requests and interventions (such as HMRC queries and systems audits). The CRM also oversees the preparation of the business’s risk assessment and discusses it with the business in order to identify and resolve any differences in opinion and engage the business in planning for future interventions. This approach enables HMRC to deepen its industry expertise and knowledge of industry-specific issues.


Despite its success in raising assessments and reducing disputes, concerns have been raised over the effectiveness of HMRC’s risk assessment process. A new Large Business Risk Task Force has recently been established to identify and manage significant risk areas such as transfer pricing and profit shifting.


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The US Compliance Assurance Process – Mike Dolan, National Director and Practice Leader, Practice, Procedure & Administration, Washington National Tax, KPMG in the US


While the US Compliance Assurance Process (CAP) is not as extensive as the horizontal monitoring programs of the Netherlands and the UK, it puts similar emphasis on mutual trust and cooperation between large taxpayers and the Internal Revenue Service (IRS). This voluntary program was pilot-tested in 2005 and made permanent in 2011. While any large business that has at least US$ 10 million of assets and meets other conditions may now apply, IRS budget constraints may limit the number of accepted applicants.


Taxpayers accepted into CAP in this voluntary program pass through three stages:


  1. Pre-cap, in which open taxation years are resolved in order to prepare the taxpayer and IRS for transition to the formal CAP program.
  2. CAP, which involves contemporaneous disclosure of current-year material transactions and tax positions
  3. CAP maintenance, which follows after the IRS has accepted the taxpayer’s risk appetite, processes and controls; in this phase, the IRS conducts only limited quarterly reviews to verify no material changes have occurred in the taxpayer’s assessed risk.

Over time, taxpayers may move back and forth between the CAP and CAP maintenance phases. In the CAP phase, corporations are required to fully disclose information concerning completed transactions and its proposed tax return treatment of all material issues. The IRS conducts a near real-time audit of disclosed tax positions and both sides attempt to develop consensus on return positions through Individual Resolution Agreements (IRA). If the filed return is consistent with the IRAs, the IRS accepts the return as filed, issues a 'no-change' letter, and no further audit activity ensues.


Taxpayers entering the program need to be willing and able to commit to a much higher level of transparency over their tax affairs. Most taxpayers report that CAP requires significant continuing resource commitment – both within the tax department and across business units.


However, based on the experience of KPMG in the US, CAP taxpayers generally prefer the program to conventional IRS large case post-filing audits. Among other benefits, the time from filing the return to closure under CAP is significantly shorter than it is for other large US taxpayers. CAP also presents valuable opportunities to engage with IRS auditors above the level of the audit team and to educate the IRS about the business’s context and its issues.


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Canada’s risk-based approach to large business compliance – Paul Lynch, Partner, Tax, National Leader, Tax Dispute Resolution & Controversy Services, KPMG in Canada


Canada’s adoption of the OECD’s enhanced relationship principles is geared to, among other things, help the Canada Revenue Agency (CRA) manage its audit workload amid increasing cost and resource constraints. Budget pressures, an expanding taxpayer population and a desire to address the audit backlog have led the CRA to direct its resources more efficiently. The CRA also recognized that its audit coverage of many large corporate taxpayers may not have been commensurate with their compliance risk.


Following some generally unsuccessful experiments with 'audit protocols' and 'real-time audits', CRA introduced a mandatory risk-based audit approach for large corporate groups (rather than single entities). These taxpayers are assigned one of three overall levels of risk: high, medium and low. In general, the level of audit coverage is then adjusted accordingly, with quick reviews for low-risk taxpayers and full audits for high risk ones. However, each audit program is individually tailored to the particular taxpayer – for example, two high risk taxpayers could still be subject to very different types of audits – one for example could be subject to an international tax audit and the other subject to an aggressive tax planning audit.


Risk assessments are based on the taxpayer’s tax filing history, relationship with CRA and industry considerations. The quality of the taxpayer’s tax governance is given priority in CRA’s approach to assessing risk. Among other things, chief financial officers can be asked detailed questions about the quality of their company’s tax oversight, controls and involvement in aggressive tax planning or unusual or complex transactions. Taxpayers are informed of their risk rating and associated level of audit activity, and they have some ability to influence changes to their ratings over time.


It appears that the OECD/CRA focus on tax governance can be credited with improvements in this area among Canadian companies in recent years. As part of a proactive approach to managing their tax risk assessments, a number of companies have started documenting their tax governance practices, developing tax risk management policies, and disclosing their tax payments, primarily in their corporate social responsibility reporting.


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Russia’s horizontal monitoring pilot program – Anton Zykov, Director, Tax Dispute Resolution & Controversy, KPMG in Russia

 

Unlike most Western countries, Russia’s tax system has only existed for about 25 years and it remains comparatively less developed. While Russia has been pilot-testing a form of horizontal monitoring, the program is not governed by any direct legislative framework and its current operational aspects and its future are unclear.


In late 2012 and early 2013, a small number of taxpayers entered into extended information exchange agreements with Russia’s Federal Tax Service (FTS). The program relies on existing laws that exempt taxpayers from fines and late payment interest if the tax authority has confirmed a particular tax position in writing.


The FTS has not issued any information on the status of the program, and there is uncertainty about how the FTS intends to assess the program’s effectiveness.


The absence of clear and enforceable rules to govern the program may hinder its further development, and extending the program will require a significant investment to recruit and train a dedicated team of auditors. A final decision on whether this program will be continued is expected in mid-2014.


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France’s proposed "relation de confiance" – Audrey Illouz, Tax Partner and Head of Tax Audits and Litigation, Fidal, Direction Internationale


On 1 July 2013, the French Directorate-General of Public Finances ushered in a form of horizontal monitoring in France with the introduction of a new 'cooperation protocol'. To date, the French Tax Administration (FTA) has signed such agreements with a limited number of large corporate taxpayers. Whether the program will meet its goal of improving relationships with taxpayers remains to be seen.


The protocol mainly consists of an upstream review of the company’s tax positions for a specific financial year. At the end of the review, the FTA issues a binding opinion discussing the tax principles applied, the tax options made by the company and the accuracy of the tax returns. The review also assesses the business’s processes to identify, examine and map its tax risks.


On entering the protocol, taxpayers commit to disclose all relevant documentation relating to the company’s organization and its tax, legal, accounting and financial audit processes. They agree to identify any interpretive issues that gave rise to analysis and to supply the tax authority with all internal or external tax opinions that were used to take tax positions or implement tax processes. This includes all the memo material from the taxpayer’s tax advisors. They also agree to voluntarily correct any issues raised by the tax authority.


In return, the tax administration commits to waive standard tax audits for the fiscal years reviewed, to issue timely written opinions on tax questions raised by the company in the course of the review (or within three months of submitting a ruling request), and to keep confidential all documents and data collected during the review. The tax authority also agrees to enforce any positions it takes in the review on all group companies in the same situation.


While the program aims to improve dialogue between the tax authority and taxpayers, experience of KPMG in the UK with tax inspectors involved in the program suggests achieving this goal may require further effort. Given the high level of transparency required of taxpayers, certain changes in the tax administration’s organizational culture may be needed before greater trust-based relationships can be built.


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Here's a replay of the webcast held on 16 January 2014.


The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.


The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.


This article represents the views of the author only, and does not necessarily represent the views or professional advice of FIDAL, Direction Internationale.


* FIDAL is an independent legal entity that is separate from KPMG International and KPMG member firms.




1 Co-operative Compliance: A Framework. From Enhanced Relationship to Co-operative Compliance, May 2013.

 

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