Corporate tax is high on the political agenda – probably higher than it has ever been. Governments and tax authorities are under pressure to collect more tax and clamp down on abuse. But it is not always easy to pin down what is reasonable and what is abusive and in some areas politically-motivated ‘quick fixes’ are causing more problems than they solve.
Looking ahead we have suggested some developing or continuing themes in international tax disputes, based on first-hand experience across our international network, which can help you manage these turbulent times. If you would like more detail on any of these issues please contact us or your usual tax or dispute resolution contact.
Tax authorities defending the local tax base
Across the globe, we are seeing increasing signs of protectionism as tax authorities are having to defend their local tax base more rigorously. We expect this trend to continue, both in mature and high growth markets.
The OECD has produced a report on base erosion and profit shifting (BEPS) and the European Commission has adopted recommendations aimed at preventing BEPS. However, international agreement over these difficult issues will take time and involve compromise. In the meantime, tax authorities are taking a more focused approach in challenging cross border transactions under existing rules, including:
- the transfer pricing of transactions between different jurisdictions, including the methodologies used and recharacterisation arguments;
- the application of controlled foreign companies (CFC) and similar rules to companies with little or no business substance, particularly in the UK and the Netherlands;
- the tax deductibility of debt and other acquisition costs in highly leveraged transactions in France, Spain and the Netherlands (including on private equity sponsored transactions);
- the interpretation and application of double tax treaties, particularly beneficial ownership issues and withholding tax exemptions, in Italy, the Netherlands and Spain; and
- capital gains withholding tax on share sales between foreign entities – we are seeing more and more assessments (especially in high growth markets where the underlying business or assets are located). A particularly concerning development is the use of retrospective legislation in this area, seen in both India and China.
Tackling tax avoidance and evasion
Taking action against tax avoidance and evasion remains a hot issue for governments, and the heat shows no sign of abating.
Across Europe and the US, the focus has been on banks and other household names, private equity houses and high net worth individuals. In the UK, there has been heated debate on the morality of tax avoidance and an increased tendency to ‘name and shame’ those accused. Those who have – or are perceived to have – engaged in tax avoidance face a number of challenges.
- Public scrutiny – in many jurisdictions, multinationals and others accused of tax avoidance have been hounded by the press, politicians and lobby groups.
- More focused and intrusive investigation – more time and money is being spent by tax authorities and prosecutors, particularly Europe and the US, investigating structured finance transactions (including those involving foreign tax credit, dividend arbitrage and leasing). We are also seeing a significant increase in the number of high profile groups being raided by the tax authorities in jurisdictions such as Germany and France, in connection with both direct and indirect taxes.
- Litigation – a more aggressive approach is being taken in litigating avoidance cases and in some jurisdictions (especially Italy, Spain and Belgium) the line between tax avoidance and tax evasion is blurring. In addition to structured finance, employment tax is a particular area of focus in France, Belgium and the UK, with the tax authorities increasingly challenging relatively ‘vanilla’ arrangements.
- Legislation – the European Commission has recommended that all EU Member States introduce a general anti-avoidance rule (GAAR) to apply in cross-border situations. Several jurisdictions, including Germany, already have a GAAR and the UK is introducing its own version later this year to tackle abusive arrangements that fail a so-called ‘double reasonableness’ test. The UK has also introduced new procurement rules requiring bidders for central government contracts to self-certify their tax compliance history.
Approach of tax authorities
A number of tax authorities under pressure to achieve results despite reduced budgets have adopted a more strategic approach to dispute resolution. This varies between jurisdictions. Some jurisdictions, such as the Netherlands, Spain and the UK, have favoured a more cooperative taxpayer relationship. This has been criticised in some quarters as lacking transparency and resulting in ‘soft’ deals for taxpayers but our experience is that cooperation coupled with the threat of litigation if the taxpayer is uncooperative has been extremely effective. Other jurisdictions, such as Italy, France and India, have taken a more confrontational approach, including increased use of domestic and cross border powers and tax raids to obtain information.
A few jurisdictions, including the UK and US, are promoting global settlement opportunities for widely marketed arrangements. Recent examples in the UK include CFCs, employee benefit trusts and film finance arrangements. The terms of these vary but tend to favour the tax authorities.
There has also been a trend towards greater coordination between tax and regulatory authorities in different jurisdictions, leading to more multi-jurisdictional and multidisciplinary investigations, and we expect this to continue. Coordinating settlements in those cases can be very challenging and requires careful preparation and an ability to deal sensibly and constructively with the relevant authorities.
When cash is tight, businesses also tend to be more litigious, including in the tax context. More contractual challenges, including tax indemnity claims, are making it to the courts rather than being settled and that trend seems set to continue.
We are also seeing more spin-off disputes, for example disputes relating to the tax treatment of settlement payments or fines and secondary liability claims, where tax authorities seek to recover unpaid taxes from third parties with deeper pockets (such as associated companies and even directors based in the same or a different jurisdiction).
European, treaty and constitutional law challenges
Although challenges to domestic legislation by reference to European law or double tax treaties seem to be on the decline in some jurisdictions (France and the Netherlands being notable exceptions), more constitutional law challenges are emerging in their stead. Particular examples include constitutional law challenges to some of the German financial crises taxes and judicial review applications in the UK. We can expect to see more of these kinds of challenges while emotions continue to run high as to the ‘fair’ allocation of tax.