Survey respondents in fact are anticipating an era of more frequent and rigorous audits. In addition to the 65% of respondents who expect that the number of TP audits will rise, 53% expect greater scrutiny of documentation and 48% anticipate more rigorous audits in general, often investigating multilateral issues or entire value chains. As for issues most likely to come under scrutiny, the top three include IP-related issues – location and ownership of assets, control of risk (cited by 38% of respondents), PE (37%) and headquarters and management services transactions (36%). Perhaps even more challenging than the sheer increase in volume of audit activity are the changes in enforcement approach and in the level of information tax authorities are requiring companies to disclose.
Heightened transparency and changing enforcement strategies
“Taxpayers today are now exposed to unprecedented levels of transparency,” Coronado says. “Country-by-country reports and TP master and local files, supplemented with a range of new and evolving national requirements and then coupled with the automatic exchange of taxpayer information, are providing tax authorities with new ways to complement the more subjective scrutiny of their tax auditors.” Audits themselves are becoming more detailed, and, increasingly, jurisdictions can be expected to begin issuing automatic assessments, leaving the burden of proof on the taxpayer to demonstrate otherwise.
Next, authorities are beginning to challenge core business decisions. “In the Tax Cuts and Jobs Act, the Internal Revenue Service (IRS) can analyze arm’s-length pricing vs. alternatives realistically available,” says Camillo. “They’re looking closely into business structures, business relationships and other choices made by taxpayers through the lens of what options did they have available? What were the competing predictions for how those business arrangements would turn out?”
Then very importantly, “what are the differences in any of the risks being borne by either party under the various alternatives?” says Camillo. “They look at licensing, cost sharing and other alternatives and ask why not one over another?”
This leads to companies starting to consider a range of forecasts with a range of potential outcomes, not just the most probable one. “You have to prove how reasonable businesspeople would evaluate the potential outcomes of a business relationship, proposal or arrangement with a particular emphasis and focus on risks,” Fultz says.
In Europe and elsewhere
Looking worldwide, “tax authorities are under urgent pressure to collect more tax,” says Coronado. The solution, says Coronado, is a more rigorous approach to tax risk management. “Principle should always prevail. In an era of more forensic, detailed audits, companies need to be proactive around TP audit readiness, taking into account not only the new types of evidence they need to present, but also understanding what new tactics they may face from auditors.”
Overall, Camillo, Wehnert, Fultz and Coronado all agree: the future is one of significantly more frequent and intensive audits and controversy.
Going forward, “though there seems general agreement on the direction, as more and more jurisdictions write more and more legislation, there are no guarantees there will be uniformity,” says Jan Bode, EY Europe West Transfer Pricing Leader. “There is a lot of change, a lot of complexity, and it all leads to greater risk.”
For these reasons, Coronado and Bode both say they are seeing renewed interest in tools such as advanced pricing agreements (APAs) – unilateral and multilateral – as well as in programs such as the OECD’s International Compliance Assurance Program (ICAP).
In general, says Coronado, “we think you’ve got to start thinking about taking action earlier in the life cycle of controversy. That means looking across governance, teaming, controls and processes, as well as more extensive use of dispute prevention and resolution programs. That means looking at your data, your people and your processes, figuring out now whether improvements are needed in order to be fit for purpose.” He continues, “Look at your tax risk assessment and look at your management of those risks, and then your dispute management and litigation procedures also. Overall, we think right now is your opportunity to prioritize and reimagine your overall tax controversy approach.”
With 56% of companies taking a minimum compliance approach to TP documentation and 35% of companies taking a shared controversy responsibility approach between local and HQ, the gap between the need for a consistent tax authority approach and decentralization will also need to be filled.
The survey does not provide evidence that companies have digested how they will fill their resourcing and process-related gaps necessary to deal with the amount of change and run side by side with the business. Amid rising complexity, 50% anticipate higher budgets for their increasing TP activities, but only marginally so. Current plans for spending on TP are likely not enough without companies taking on additional risk. Transfer pricing enforcement is evolving to become more active. With tax controversy on the rise, alignment with the business will be essential to a tax department building sustainable and flexible operating models that can be understood by tax authorities.
Forging a response
Joel Cooper, EY Global International Tax and Transaction Services Controversy Leader, also predicts an era of significantly more controversy ahead. “Controversy will definitely expand. The frequency of controversy will increase, as will the breadth and depth and the expectations and requirements from authorities,” he says.
In fact, 56% of participants believe there is uncertainty in TP, creating an unstable environment and decreasing the ability to depend on past settlements and court cases for current enforcement guidance. With over 50% of respondents still relying on their past experiences to assess TP risk, there is a greater need to understand how TP audits are resolved currently and what is being required.
“Audits will become longer and more demanding. Information requests are wide in scope, and authorities will be accessing all the information you can imagine,” says Cooper. “From social media to filings with other countries, tax authorities will want to use it all. Moreover, as this evidence-based approach to audits expands, increasingly we see a push from tax authorities to move to show, not tell.” And sometimes, requested information is in addition to specific items listed for disclosure by the OECD.
In particular, Mikael Hall, EY UK & Ireland Transfer Pricing Leader, sees national tax jurisdictions “beginning to look into entire value chains across corporate and national boundaries. They’ll look at customs duties and R&D filings to see how these mesh with your transfer pricing reporting. They’ll look at your global and regional profitability and any rulings and positions taken in other countries, and they’re going to be looking to see where there’s inconsistencies.” In fact, companies registered tax authority data analytics, information sharing and volume of audits as the largest issues in controversy management.
For TP executives, “they’re going to need to become more proactive in controversy management. And to do that, they’re going to have to do all they can to streamline, simplify and automate their work so their resources can focus more [acutely] on controversy preparedness and response.”
In addition, Cooper believes more companies will seek greater assurance through tools such as bilateral and multilateral APAs or even the ICAP and will more proactively (and more regularly) seek to resolve double taxation through the use of the mutual agreement procedure (MAP).
“My feeling is that with the risk of controversy on the rise, we’re going to see more companies seeking more assurance,” says Cooper. “And so we’re also going to see more companies using these tools to reduce their risks and avoid double taxation.”
Interestingly, businesses with the largest TP departments (30 or more dedicated people) said the number one trend they see in the marketplace is significant improvement in TP dispute resolution processes. Among smaller departments, this trend ranked lower.