5 minute read 17 Jun 2019
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Six ways top businesses manage multiple tax controversy risks

5 minute read 17 Jun 2019

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Risk factors include whether businesses are large, have global reach, have cross-border flows or are “virtual.”

Tax disputes the world over are on the rise. This is a view with plenty of empirical support.Our recent EY Tax Risk and Controversy Survey shows that tax controversy management is becoming somewhat or significantly more important for 55% of global businesses, increasing to 64% of large global businesses.

But where are the risks greatest and possibly growing — and what can be done to mitigate them?

Four characteristics 

Conversations with Rob Hanson, EY Global Director, Tax Controversy; Howard Adams, who leads the EY Global Tax Controversy Desk; and Jean-Pierre Lieb, EMEIA tax policy and tax controversy services leader at Paris-based Ernst & Young Société d’Avocats, indicate that controversy is on the rise for international businesses of all shapes and sizes. However, the risks rise significantly for companies displaying any of the following attributes: 

  • The business is large. In Hanson’s view, “it’s fairly clear from what we’re seeing that governments [the world over] tend to target the largest enterprises for tax and especially transfer pricing audits.” This makes sense, says Hanson, “because naturally, this is where the cash flows are greater and more value is at stake, so it warrants their investing greater resources and focus.”
  • The business has significant global operations. The rise in tax controversy “really is a global phenomenon,” says Hanson, who leads a worldwide network of tax controversy professionals. Where some individual nations are proving more aggressive than others, there are also entire regions where controversy is on the rise, including much of Europe and Asia — and in particular, emerging markets. Generally speaking, he explains, “controversy today can arise almost anywhere.”
  • The business has extensive cross-border flows between affiliates. Authorities are laser-focused today on transfer pricing. As Adams explains, for tax authorities, “it’s a lot easier to make a transfer pricing adjustment than to deal with complex technical issues” .Moreover, as tax authorities gain greater access to data, for example, via base erosion and profit shifting (BEPS)-driven Master Files and CbC reporting, their efforts are becoming more targeted. Consequently, “transfer pricing is [becoming the tool of choice] for most revenue authorities — it may be a blunt instrument but for their purposes, it’s quite effective.” Making matters even more challenging, says Hanson, is the fact that tax jurisdictions are becoming much more active in sharing taxpayer data with one another. This “increasing frequency of simultaneous audits involving multiple jurisdictions” is adding fuel to both the frequency and complexity of controversy
  • The business is “virtual” or uses high levels of intellectual property (IP). “Technology companies are [relatively] high-risk subjects due to the virtual nature of their businesses and almost by definition, their reliance on and use of intellectual property,” says Hanson. The pharmaceuticals industry also faces relatively heightened scrutiny due to similar levels of IP and also “significant cross-border cash flows.” 

Reducing the risks 

Tax authorities are absolutely within their rights to demand that businesses apply tax rules appropriately. But at the same time, that means businesses themselves must become better prepared to prevent, manage and resolve tax controversy. 

Appropriate preparation requires attention to myriad issues: 

  1. Get better connected. One of those most critical issues, says Hanson, is making certain that the C-suite and board are connected into the conversation and are keenly aware “that we’ve entered an era of vastly greater tax transparency.” Accordingly, should controversy arise — or even a tax raid — it becomes absolutely essential that tax policies and practices are ready for the light of day. 
  2. Be prepared for a greater number of challenges. “The number, the frequency and the scale of audits is rising,” says Lieb. One driver is the implementation of the multilateral instrument (MLI) called for under the BEPS initiative. The stated goal of the MLI, says Lieb, is to update and harmonize the world’s 3,000-plus bilateral tax treaties.But this process will also lead to a wide range of unexpected outcomes, for example the disallowance of previously permitted transactions. In addition, within the MLI is a principal purpose test (PPT), “an opportunity for jurisdictions to evaluate whether or not a business is structured primarily to obtain tax benefits under a given treaty,” says Lieb. Given the number of treaties under review, it is likely that in the coming months and years, there will be numerous existing structures that will be deemed inappropriate, leading to a limitation of benefits (LOB). 
  3. Adopt a risk management approach. Hand in hand comes the recognition that tax should no longer be treated as a mere compliance issue. Tax risk is “more than just the cost of any defense or adjustment in any single jurisdiction,” says Hanson. Indeed, it can also negatively impact reputation, which can lead to a whole range of issues involving customers, suppliers, investors – or host nations. Consequently, says Hanson, “companies need to begin thinking strategically about their tax risk.” This means “a more robust, clearly discernable and defensible strategy that cascades through the business.”
  4. Consider options for greater certainty. A growing number of nations are today offering more options and more streamlined application and approval processes for tools such as advance pricing agreements (APAs). “Businesses hoping to reduce their tax uncertainty,” says Lieb, should give such instruments a closer look.
  5. Respond rapidly. This leads to the idea of maintaining contemporaneous documentation of all transfer pricing arrangements. Be prepared, in particular, to share supporting evidence such as your company’s functional analysis. Moreover, stay constantly in position to move swiftly, answering any initial inquiries as completely and competently as possible. Says Adams, “that first touch is critical.” Delays lead to closer scrutiny; any missteps in setting the tone with any regulator “makes it very hard to rebuild your image.”
  6. Formalize your process. Overall, a global business needs to establish a formal and comprehensive tax controversy framework. Not only will your group be better equipped to track, monitor and learn from its global controversy matters, but as Lieb explains, “you can minimize surprises, better organize your response and increase your prospects of a superior outcome.” 

This article was originally published in Tax Insights on 7 Nov 2017

Summary

Tax authorities are completely within their rights to demand that businesses apply tax rules appropriately. That means businesses themselves must become better prepared to prevent, manage and resolve tax controversy.

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