How businesses should react to rising tax disputes

Businesses can take a big first step by confirming that their transfer pricing practices are up-to-date and BEPS-compliant.

Businesses that find themselves locked in a dispute with tax authorities today face this statistic: the number of unresolved mutual agreement procedure (MAP) cases has grown 163% since 2006, according to the Organisation for Economic Co-operation and Development (OECD).

MAP cases arise in situations where two or more parties are unable to reach an agreement following an audit and subsequent negotiations.

The increasing number of MAP cases — they rose by 14% in 2015 — provides an indication of the degree to which tax disputes are rising, according to Paris-based Jeffrey Owens, Senior Tax Policy Advisor at EY.

As tax controversy rises across the world, so does the need for more effective dispute resolution mechanisms, especially across borders.

Worse before better

Transfer pricing itself accounts for 80%–90% of current tax disputes, says David Canale, Washington, D.C.-based EY Global & Americas Leader, Transfer Pricing Controversy Services.

While different plans are underway to improve these mechanisms, including through the OECD’s base erosion and profit shifting (BEPS) project, it will take time to implement them broadly across the world.

“With the expected surge in controversy, tax authorities are likely to have their hands so full that resources and focus will be under severe strain,” Canale says. “The reality is that even with these efforts to improve dispute resolution, matters are going to get slightly or even potentially much worse before things overall begin to improve.”

Who gets the tax base?

Today’s volatile controversy environment is being shaped by stricter enforcement, as governments continue to look for new ways to raise revenues.

In addition, the BEPS initiative could lead to more disputes in the years ahead as governments share more information but have different views on a taxpayer’s filing.

“The BEPS rules require a detailed functional analysis requiring specialist knowledge of each company’s business model, plus a series of subjective judgments,” says Sol Picciotto, Emeritus Professor at the UK’s Lancaster University Law School. “Few jurisdictions have the resources to do this for every business; it’s almost a recipe for uncertainty and dispute.”

The local tax dispute of the past will increasingly become global in nature.

Morrie Cheng, MetLife’s Hong Kong-based Vice President for Asia Tax, says that almost all audits today are territorial.

In the next few years, however, Cheng expects that there will be more joint audits involving two or more nations and that those audits would lead to more MAP cases.

New resolutions

The tax uncertainty is expected to lead to a surge of cross-border disputes, which makes it urgent for a clearer and more effective dispute-resolution process.

One recommendation prescribes specific improvements to MAP, seeking to resolve MAP cases within a two-year time frame.

To do so, G20 nations and others must join in this convention to subscribe to minimum standards related to dispute prevention, access to MAP processes, resolution of MAP cases and implementation/follow-through on MAP conclusions, in addition to peer review.

Owens believes requiring peer review is compelling.

Each participating tax administration will be monitored and reviewed by all the others who will be able to issue red, yellow or green cards against various criteria.

“For those countries that participate, it should lead them to allocate more resources and work more cooperatively,” Owens says.

Reluctance in the developing world

The main obstacle is that the countries with the skills and resources, such as Germany, are signing on to the change, while many developing countries continue to hesitate, according to Owens.

Nonetheless, he believes there are incentives for all nations to improve their dispute resolution. “No one wants a bad business rating, as that can hurt foreign direct investment,” Owens says.

India, for example, is already working more closely with the US to settle a backlog of MAP disputes. At a special October 2016 working session in Washington, DC, Indian and US authorities concluded over 100 pending MAP cases — many of them long-standing.

Another BEPS initiative aimed at delivering greater certainty prescribes the development of a multilateral instrument that will be used to help harmonize various definitions, treatments and conditions described in global tax treaties. It is an essential step, as the 15 actions within the BEPS project, including the improved dispute-resolution process, would require lengthy amendments on a treaty-by-treaty basis without this mechanism.

In late November 2016, over 100 jurisdictions concluded negotiations on this instrument, which will now be used to update more than 3,000 treaties worldwide. “This will help clarify rules and add greater transparency and consistency that should help to reduce the number of issues up front,” says Canale.

Mandatory dispute settlement

In a world characterized by political and economic uncertainty, governments need to avoid adding tax uncertainty, which in turn requires that cross-border tax disputes are resolved quickly and effectively.

This is why businesses and many governments are pushing for mandatory arbitration as a safety net to the traditional MAP process. So far, 20 nations have committed to binding mandatory arbitration, according to Achim Pross, Paris-based Head of the OECD’s International Co-operation and Tax Administration Division.

He expects more to join in the near future and sign up to the arbitration provision in the multilateral instrument that the OECD recently released. Here again, the challenge is widespread implementation. For now, the countries where binding arbitration is most needed are refusing to join, according to Canale.