Increased global transfer pricing scrutiny and tax controversy
(As originally appeared in FEI Canada F.A.R. member e-newsletter, November 2010)
By Gary Zed, Canadian Tax Market Leader, Ernst & Young LLP and Fred O’Riordan, National Advisor, Tax Services, Ernst & Young LLP
Distressed global financial markets have driven governments to react to changing circumstances in order to preserve their revenue bases and finance their economic recovery. Comparatively, Canada has weathered the storm better than most; still, the Canada Revenue Agency (CRA) is reacting by amplifying enforcement, specifically related to transfer pricing.
Transfer pricing — the leading tax issue facing multinationals — is the valuation of cross-border transactions between related entities, and has proliferated with globalization. Consequently, recognizing and properly managing the risk associated with transfer pricing and tax controversy is critical for global businesses.
As the CRA works to improve its risk assessment capacity and reallocate audit resources accordingly, small and medium enterprises may be affected the most — with transfer pricing reviews ushering in heightened audit exposure and risk. The CRA transferred responsibility for the Basic File audit program to the same group that is responsible for the Large File program. The CRA feels an opportunity existed to improve compliance in the substantially larger Basic File taxpayer populations, which are made up of businesses with annual gross revenues of between $20 million and $250 million. They’ve achieved this improvement by better risk profiling and applying similar transfer pricing resources and audit techniques similar to those used in the Large File program, which consists of the 900 or so large businesses with annual gross revenues of $250 million or more.
Global tax efforts to safeguard markets
Tax administrations worldwide share taxpayer information through their network of bilateral tax treaties. Many low-tax jurisdictions, so-called “tax havens”, do not have treaties, so treaty countries have instead developed tax information exchange agreements (TIEAs) as a way tax of improving their access to international sources of taxpayer information. Canada has developed an International Tax Fairness Initiative, which enhances Canada’s ability to collect tax information from other jurisdictions through revised tax treaties and TIEAs with non-treaty countries.
Risk management crucial for staying afloat
In light of new transfer pricing jurisprudence and growing worldwide tax controversy, businesses face a highly complex tax environment in which to operate. As organizations get ready for the CRA’s intensified transfer pricing implementation, a proactive approach is needed to mitigate the impact of increased tax controversy and risk.
In order to guide businesses through the changing global tax controversy and risk management landscape, there is a growing need for professional services firms to expand their transfer pricing practices. A recent report from EY, Tax administration without borders, outlines the rapid succession of tax policy and suggests that to successfully manage global tax controversy and risk, companies should do the following:
• Adopt a global approach. Develop strategies and actions from a broader global perspective, since this is how the CRA and other tax administrations will be viewing them. This will also improve consistency of documentation across borders.
• Evaluate global systems and resources for tax risk management. Ensure that the right processes are in place to effectively manage these risks before filing a tax return.
• Mange your ongoing and potential controversies at a strategic level. Dealing with tax controversies as they arise is not sufficient. Develop and execute comprehensive strategies to anticipate, avoid and mitigate controversy issues.
• Include global tax risk as a corporate governance issue. Tax administrations are encouraging the presence of tax strategy on the corporate boardroom agenda, and expect board members to be responsible and accountable for business tax strategies and outcomes.
• Stay connected with tax policy and legislative changes. Changes in tax policy legislation and regulation can create both significant risks and opportunities. By understanding the context of policy decisions, companies can get a head start on implementing a pre-controversy strategy.
Domestic and international pressures are pushing companies globally to improve their cash balances and gain operating efficiencies by rationalizing their business operations in ways that minimize their tax burdens. Ultimately, the goal is to gain achieve greater certainty around global tax positions, tax reporting and tax planning in a way that aligns with the principles of good corporate governance and satisfies the concerns of both parties.