Around the world, levels of tax disputes have reached record heights, and the rise in tax controversy shows no signs of abating. As Sharon Katz-Pearlman explains, the forces driving this tax authority activity are numerous and complex. In this article, Sharon discusses the top five factors that are coming together to fuel this global trend.
The global downturn has taken its toll on government finances, and tax authorities in most developed countries are being pressed to raise more revenue from their tax bases with fewer resources. Tax authorities are responding by getting more aggressive in tax audits and investigations, resulting in larger adjustments and more potential for penalties and interest.
|Global Tax Dispute Resolution & Controversy|
|Top 5 Driving Factors|
- Fall-out from economic downturn
- Tax authority’s focus on cross-border movement of profits
- Tax authority’s information sharing and collaboration
- Challenges on expanding into emerging markets
- Rising emphasis on tax certainty
A second, perhaps less obvious outcome of the financial crisis is a new focus on the link between taxation and morality. As fiscally challenged governments impose austerity programs and attempt to boost their tax revenues, the general public is growing more hostile toward corporations and high net worth individuals who shirk their tax payment obligations.
These changing public perceptions are giving tax authorities a stronger mandate for tackling tax avoidance and evasion. In fact, tax morality has been used to justify moves to upset long-standing principles such as bank confidentiality rights and taboos against extraterritorial and retrospective tax legislation, arming tax authorities with tough new tax enforcement tools.
With globalization and the increasing mobility of economic activity, governments are worried about defending their tax bases against inappropriate profit shifting and other tax avoidance. Tax authorities want to make sure they collect an appropriate amount of the profits earned in their jurisdictions, and they are upgrading their skills and resources for international tax inspections.
As multinational businesses create global holding company and management structures, tax authorities are giving these structures a closer look to ensure that the profits allocated to them are reasonable.
As a first line of attack, many tax authorities would seek to challenge international structures under anti-avoidance rules based on a lack of business substance. Transfer pricing disputes over the appropriateness of cross-border payments to related parties are also becoming more common. Many tax authorities will seek to impose exit charges on business restructurings that move functions and risks from one jurisdiction to another. Treaty-based holding company structures are also on the ropes, as tax authorities seek to deny treaty benefits based on positions regarding beneficial ownership of the international company’s income.
As you can imagine, resolving these kinds of disputes can be extremely complex, especially when multiple tax authorities are involved.
Tax authorities are working together much more closely than ever before these days: entering new agreements to share taxpayer information, leveraging existing ones more frequently, and showing more willingness to collaborate on bilateral advance compliance programs such as Advance Pricing Arrangements. Within their own countries, they are getting better at sharing taxpayer data between departments, such as between tax and customs or immigration. They are also making more sophisticated use of technology to collaborate on activities such as income matching and data mining.
In the future, more formalized joint international tax audits for global companies could become the norm, if countries take up the Organisation for Economic Co-operation and Development’s (OECD) Forum of Tax Administrator’s 2010 recommendation and guidelines for their conduct.
The Forum was created by the OECD in 2002 with the aim of promoting dialogue between tax administrations and of identifying good tax administration practices. Since then, the Forum has led the way in a number of tax administrative initiatives, starting with its global project to shut down tax havens and harmful tax practices.
More recently, the Forum has incubated new tax audit approaches based on an “enhanced relationship” between tax authorities and taxpayers, along with risk-based tax audit processes that base the extent of audit coverage on the quality of its tax governance, processes and controls.
Of course, the OECD Forum on Tax Administration is only one of several international bodies bringing tax authorities together to collaborate and share leading practices. Other active organizations include the Joint International Tax Shelter Council and Pacific Association of Tax Administrators, which is particularly active in the area of transfer pricing, documentation and mutual agreement procedures.
When companies expand into emerging markets, they often find their dealings with the local tax authorities to be quite different—technically and culturally—than they are closer to home. Many tax administrations in emerging economies lack features, such as binding tax rulings, standard procedures, proper appeal regulations and electronic tax filing facilities, that taxpayers in more developed countries take for granted. Treatment of tax issues can be inconsistent, technical guidance may not exist, and recourse through appeals may not be an option.
Companies that are new to these markets should engage local professional advisers with in-depth knowledge of the tax system and familiarity with tax authority personnel—advisers who can help them avoid missteps and optimize local after-tax returns. They also should bear in mind that tax authorities in most emerging economies are rapidly catching up to their more sophisticated counterparts. Companies should ensure their approach to the tax authorities evolves accordingly.
Tax authorities want to deploy their audit resources efficiently and effectively, and so they are using a variety of techniques to help them focus on taxpayers with the highest risk of non-compliance. Some tax authorities have been given legislative tools to help them better target tax avoidance.
For example, In the United Kingdom, senior accounting officers of large companies must annually certify that their tax systems and controls are adequate. The United States requires companies to report “uncertain tax positions”—which are not certain to be upheld on audit—on their balance sheets and on their tax returns. Current tax authority risk assessment programs in the United Kingdom, Australia and Canada are evolving toward an OECD-endorsed model based on the strength of the company’s tax governance policies.
By directing their attention toward taxpayers and transactions with the greatest uncertainty and risk, tax authorities are better able to detect non-compliance and increase the number and amounts of taxes they assess on audit.
Definitely. Tax authorities have introduced a range of programs to help tax inspectors and taxpayers achieve certainty on the tax treatment of transactions before tax returns are filed. Advance pricing agreements, which fix a company’s transfer prices for several years in advance, are becoming a common feature of many transfer pricing regimes. Many countries offer forward compliance programs as part of their value added tax systems, and pre-clearance procedures have become a valuable component of many customs regimes. Voluntary disclosure programs may allow taxpayers to correct previous omissions and errors without the risk of incurring additional penalties and interest. Advance interpretations and binding tax rulings continue to play an important role in providing advance certainty on potentially controversial areas.
The horizontal monitoring and enhanced relationship programs mentioned earlier are also important steps in this direction. By establishing open dialogue and addressing tax issues in real-time through these programs, tax authorities can defuse disputes before they happen. At the same time, companies can manage tax risk more effectively, eliminate their need to disclose tax uncertainties in their accounts, and integrate tax issues more efficiently at the time deals are being structured.
In this climate, it is ever more important to approach your tax matters proactively and be ready to respond if and when a local tax investigation begins. When dealing with tax authorities, you need to be well prepared, well organized and in complete control of your facts and issues. This means understanding why transactions or tax positions were taken, being able to explain the technical basis of your understanding, and being ready to back-up your assertions through clear, comprehensive documentation.
Taking a broad ranging, proactive approach will help ensure you are well equipped to face any tax dispute scenario and help improve your chance of a favorable outcome.
Sharon Katz-Pearlman is the national Principal-in-Charge of KPMG’s Tax Controversy Services practice in the United States and Head of KPMG’s Global Tax Dispute Resolution & Controversy team. Sharon works with clients on all aspects of their IRS matters, dealing with a variety of domestic and international tax issues, focusing primarily on representation before the IRS of multinational corporate clients and financial institutions. She provides assistance in all facets of alternative dispute resolution, as well as traditional examination and appeals consulting. Before joining KPMG, Sharon was a Special Litigation Attorney with the IRS Office of Chief Counsel in Manhattan, where she responsible for the development and litigation of major tax matters before the U.S. Tax Court and served on a number of litigation teams.
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