This article summarizes our collective experience working with cross-border businesses and tax authorities. Whether you are responding to a request for information from tax authorities, dealing with a diverted profits tax assessment, managing an international tax or transfer pricing audit, or trying to resolve disputes with tax authorities, here are some tips that you may wish to consider:
- Keep your house in order. The first step to any audit and controversy defense should start long before questions are posed by local tax auditors. This means establishing a global overview of your businesses, having proper legal agreements and well-documented functional profiles for all your entities. Traditional tax advisors are often too inbound-oriented to advise their clients on this basis, but with the introduction of requirements for Master File and Country-by-Country reports following OECD transfer pricing guidelines, this outbound view has become more critical to the management of audit and controversy risks. Keep your house in order by starting from this global outbound viewpoint, and make sure that local requirements are met in ways that are consistent with this global overview, and that up-to-date, carefully drafted, intra-group agreements are in place.
- Be proactively transparent. The traditional resistance to answer questions about foreign activities vis-à-vis local functions needs to give way to a more proactive engagement. There is no point in putting up barriers to transparency. Whereas in the old days you may claim that certain information is held overseas and cannot be presented to local tax authorities, this is becoming less and less viable in the post-BEPS environment. Tax administrations themselves have put in place various forms of exchange of information mechanisms; they regularly attend multilateral conferences and meetings where experiences and audit strategies are shared, as well as having access to the vast array of public information available online (financial statements, press releases, LinkedIn etc.). Increased reporting of and transparency for tax positions arising from the new, three-tiered transfer pricing documentation requirements, the exchange of country-by-country reports and the upcoming mandatory disclosure rules in the EU also mean that lack of transparency is no longer an option – the only question that businesses need to consider is whether they would prefer to present the information themselves or have that information available elsewhere without their proactive engagement.
- Presentation of facts is critical. Facts will dictate the appropriate tax treatment of international transactions in the post-BEPS era; from accessing lower withholding tax rates under tax treaties, examining the existence of a permanent establishment, through to transfer pricing arrangements. Multinationals that think proactively about how they present the substantive elements of their cross-border businesses will be in a better position to successfully defend their tax positions. A willingness to engage in this way may be new to many advisors and their clients, but tax authorities are also on a new learning curve.
- Take the time to establish a mutual understanding of the facts. In the post-BEPS environment, not providing information can be worse than providing it as authorities' presumptions are often already skewed by the perception of information asymmetry. Tax authorities often have the idea of being disadvantaged because of information asymmetry, which leads them to adopt approaches that are often considered aggressive. A proactive approach to establishing a mutual understanding of the facts puts everybody on the same page and allows all parties involved to take steps to address disagreement or misunderstandings before engaging in technical discussions. In our experience, potential disputes can often be resolved before they start if businesses engage in this way. This is especially the case for transfer pricing issues, where misunderstandings or disagreements as to facts (and not technical issues) is often what is at the heart of the dispute.
- Less information can be more effective. Sending more information as a reaction to information requests is not necessarily the most productive, and can often end up being disruptive. For example, it is often the wrong approach to answer a request about service benefit by providing a list of all the services offered by the provider; in such circumstances, it is often better to focus on the services that are actually used by the local entities, then clearly provide evidence to demonstrate the benefits of such services. An offer to meet with tax authorities to proactively discuss an information request before responding, and then another meeting to explain the information provided in the context of your business can set you and the tax authorities on the right path – the urge to overload tax authorities with information should generally be contained.
- Avoid investment bias. Tax authorities' job is to ask questions in tax audits and they often have limited time to perform their tasks. Once tax authorities are engaged for a long time, they will want to (and be under pressure to) produce results, no matter how unreasonable the outcomes may sound to you. Stringing them along with drawn-out processes and unnecessary delays can create an investment bias and can ultimately be a counter-productive strategy. Cases that could have been closed out and decided quickly should not be dragged out through old-fashioned tactics that will backfire once investment bias sets in. Sometimes, choosing not to defend the indefensible is the best start to an audit as this will ensure a proactive engagement on both sides to reach a sustainable, pragmatic outcome.
- Be prepared to take a multilateral approach. Tax authorities work together and you can make that work for you. Mutual agreement procedures (MAPs) have been around for many years, but there has been a revival in the post-BEPS environment because of the OECD’s work with the competent authorities and the peer review process under Action 14 of the OECD BEPS Action Plan. Countries have established a better system for businesses to access these procedures; once access has been granted, the dispute resolution process has become much smoother than before and the results are more reliable. The latest statistics (2017) show that over two-thirds of cases accepted into MAPs are resolved either unilaterally or bilaterally. Furthermore, competent authorities do not normally charge taxpayers to access MAP. If you have your house in order, there is generally no reason not to a use this procedure when it is available.