7 minute read 25 Feb 2021
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Why businesses expect a shift from COVID-19 tax relief to enforcement

Authors
Kate Barton

EY Global Vice Chair – Tax

Helping organizations develop smart tax strategies. Passionate about diversity, women in business and tax tech.

Luis Coronado

EY Global Tax Controversy and Transfer Pricing Leader

Vast cross-border experience. Well-versed in international tax. Thought leader in tax policy and controversy and transfer pricing.

7 minute read 25 Feb 2021

Tax administrators helped businesses during the COVID-19 pandemic. As they seek revenue, new areas arise for potential tax controversy.

In brief
  • Tax authorities provided significant levels of administrative relief during the pandemic.
  • Governments are expected to impose a higher tax burden and resume robust enforcement to reduce budget deficits.
  • Respondents to the 2021 EY Tax Risk and Controversy Survey say transfer pricing, worker mobility issues, treatment of losses and use of stimulus measures are big concerns.

Companies may soon experience new tax audits of several COVID-19-related tax issues, according to 1,265 tax and finance leaders who responded to the 2021 EY Tax Risk and Controversy Survey.

Tax authorities played a pivotal role in governments’ responses to the economic impacts of the global COVID-19 pandemic. Almost 140 jurisdictions provided relief that included delayed filing deadlines, deferred collection of some taxes and a pause in audit and litigation activity, according to the EY Tax COVID-19 Response Tracker. They also deployed massive levels of support and stimulus measures enacted by policymakers.

A year into the pandemic, however, and administrative relief has come to an end in most jurisdictions. Survey respondents highlight several areas of tax where they believe tougher enforcement – and examination – awaits as governments pivot to raising revenue to cover new fiscal deficits. Higher enforcement will be joined by higher tax burdens, say respondents, with more than half forecasting a higher direct tax burden in the coming three years. “We are already seeing some governments shift their focus to raising revenue” says Luis Coronado, EY Global Transfer Pricing and Tax Controversy Leader in confirmation. “That means companies will now have a completely new set of issues to assess and manage from a tax risk and controversy management perspective.”

We are already seeing some governments shift their focus to raising revenue.
Luis Coronado
EY Global Tax Controversy and Transfer Pricing Leader

Administrative challenges

Although business welcomed 2020’s administrative relief, companies must wrestle with several ongoing impacts on tax administration.

In our survey, 48% of respondents said they generally experienced delays in their dealings with revenue authorities. Counterintuitively, these delays were more likely to have occurred in mature markets — in North America, for example, the figure rises to 65%.

Just 28% of respondents reported a slowdown in incoming enquiries from tax authorities, though, confirming that much tax work continued as usual, although 35% did note a concurrent slowdown in tax audit and litigation activity. At the same time, there are signs that increased use of technology may have had a positive impact, with 26% (rising to 38% in Asia-Pacific and 44% in Central and South America) reporting improved engagement with tax authorities due to the use of tools such as virtual meeting platforms.

Tax treatment of pandemic-related issues

A plethora of tax challenges and disputes is expected as a result of the pandemic, with issues around worker mobility, pandemic-related losses, the claiming of tax refunds and even the receipt of stimulus measures themselves identified as major concerns.

Tax issues related to the stranding of personnel overseas as a result of travel bans and immigration changes were the leading pressure point, highlighted by 45% of respondents. Both the Organisation for Economic Co-operation and Development (OECD), and several countries have issued related guidance, and many nations have temporarily relaxed certain tax rules to try and mitigate the problem, which affects both worker tax and social security and wider permanent establishment risks.

Tax risk

53%

Say they expect tax enforcement to increase after the pandemic.

Differing tax treatment of COVID-related tax issues (such as losses) is expected by 39% of respondents, rising to 48% in Asia-Pacific and 52% in Central and South America. This is not surprising, given 2020 changes to loss treatment (some temporary in nature) documented in at least 10 countries in the EY Tracker. While taxpayers may be keen to try and turn losses into deferred tax assets, opportunities to do so should be carefully assessed and managed from a tax risk perspective.

Other concerns voiced by respondents include the possibility of being tax audited as a result of receiving support or stimulus measures. In the United Kingdom (UK), for example, Her Majesty’s Revenue and Customs (HMRC) has estimated that somewhere between £1.75 billion and £3.5 billion could have been incorrectly claimed (including fraudulent claims) under its Coronavirus Job Retention Scheme. While HRMC has said that it will not pursue legitimate mistakes, multinational companies (MNCs) should consider making a systematic review of claims under all similar programs; 28% of survey respondents say they see potential for new tax audits in this area.

Some 35% of respondents expect that cross-border businesses will see different transfer-pricing interpretations as a result of the pandemic. That concern has already led the OECD in late 2020 to issue new guidance, setting out clarifying comments on and illustrations of the practical application of the arm’s length principle to the unique fact patterns and challenges arising during and after the pandemic.1

Tax enforcement

In the enforcement area, increased scrutiny, while widely expected by respondents, is likely to vary widely by country. Geographic hotspots will continue to present challenges, while many tax administrations are likely to move ahead with new digital data submission requirements and broader transparency and disclosure laws. Italy, Mexico, Poland and the United Kingdom have all seen new disclosure developments recently.

A number of countries are already known to be scrutinizing the largest MNCs more closely than before, looking for any tax uncertainties that may drive new tax audits and subsequent settlements. Several such countries have already announced tax settlements in the hundreds of millions, even billions of dollars, with extensive media coverage accompanying these developments. More countries may see that and follow suit.

New “forensic” tax audits and documentation requirements

Respondents’ concerns are based on real-world activity. In Japan, the resumption of audits in October featured fresh scrutiny of multinational companies’ cross-border transactions, as well as creating new requirements demanding near-forensic levels of supporting documentation.

Japan’s National Tax Authority also reports that transfer pricing adjustments have tripled in the last three years, from $2.2 to $6.6 billion.2 Japan is unlikely to be alone in doing so.

Transfer Pricing documentation is also being examined from a customs perspective in Japan, says Yoichi Ohira, a partner in the EY global indirect tax network, reflecting a broader move in this direction. Many tax authorities in Asia-Pacific are now asking importers to explain their approaches in far more detail, with Ohira forecasting heightened scrutiny of the origin certificates used to claim duty-free status bestowed by free-trade agreements.

Indirect taxes on the rise

While VAT fell in many countries during first months of the pandemic (albeit temporarily in some and in a very targeted manner in most, benefitting the travel and entertainment sectors and the purchase of both Personal Protection Equipment and basic foodstuffs), the direction of change was not universal. In May 2020, for example, Saudi Arabia announced it would triple its VAT rate from 5% to 15%, in effect abandoning a long-term plan to introduce VAT at a low level and raise it gradually.Colombia, Oman, Qatar and Ukraine similarly look set to have higher VAT rates in 2021.

Europe is also likely to experience a rising indirect tax burden in 2021, says Gijsbert Bulk, EY Global Indirect Tax Leader. “By eliminating reduced rates or exemptions, governments and authorities will broaden the base of VAT. They will also apply more scrutiny to what they’re seeing from taxpayers,” he says.

By eliminating reduced rates or exemptions, governments and authorities will broaden the base of VAT. They will also apply more scrutiny to what they’re seeing from taxpayers
Gijsbert C. Bulk
EY Europe West Deputy Tax Leader

Actions to take now

Many MNCs confronted with the existing challenges of post-COVID-19 tax scrutiny, new forensic documentation requirements and potentially major changes in international tax rules are considering whether there is a better way to manage tax controversy.

To prepare, many are investing in a broader, company-wide approach to tax risk and controversy management. The survey shows that 50% of responding companies use a Tax Control Framework (TCF), a model under which tax-risk management processes are embedded across all tax decision-making and more corporate processes. Such companies tended to report better tax risk management outcomes than others in the EY survey. Seventy-six percent, for example, say they have either complete or substantial visibility over open tax audits globally – somewhat higher than the 65% for non-TCF users.

An effective TCF can be a useful starting point in developing the Tax controversy department of the future, a framework approach in which all tax controversy is managed in three distinct solutions: tax risk assessment, tax risk management and tax audit management.

Each solution is comprised of many detailed processes, with many individual leading practices available to choose from. The three solutions are further supported by leading practices in the areas of organizational model and relationships, both internal and external. The right tools and technologies can help track and manage disputes, while the leading practice may even collate all tax data into one place before utilizing data analytics, machine learning and artificial intelligence to try and predict where future disputes may occur.

The tax environment is shifting faster than ever before and only a limited window of opportunity exists to prepare before several key trends, discussed above, converge. Companies should be careful to not let the window close upon them.

Reproduced with permission. Published February 24, 2021. Copyright R 2021 The Bureau of National Affairs, Inc. 800-372-1033. For further use, please visit https://www.bloombergindustry.com/copyright-and-usage-guidelines-copyright/

 

Summary

Tax administrators played a critical role in helping governments administer pandemic-related support and also provided relief such as delayed filing deadlines and pausing enforcement activities. Respondents in the 2021 EY Tax Risk and Controversy Survey expect governments to pivot back to raising revenue and more robust enforcement to close budget gaps, and issues like transfer pricing and worker mobility are pain points.

About this article

Authors
Kate Barton

EY Global Vice Chair – Tax

Helping organizations develop smart tax strategies. Passionate about diversity, women in business and tax tech.

Luis Coronado

EY Global Tax Controversy and Transfer Pricing Leader

Vast cross-border experience. Well-versed in international tax. Thought leader in tax policy and controversy and transfer pricing.