Companies redouble TP efforts over dispute fears

“It’s not just an occasional bolt-on to the day-to-day operations of a tax department,” one TP director at a British company said. “Managing the risk of disputes has become the number one priority for many tax leaders.”

The risks of getting caught off guard can damage profitability and cost a company its reputation. The tax authorities are also facing pressures over how to find the resources to deal with disputes, especially as many revenue services are underfunded. The costs are high for both parties as court cases can take years, or even decades, to conclude.

“This is at the forefront of what a corporate tax department does now,” the director said. “It’s not just about what could happen in the future.”

Despite fighting multiple cases in recent years, the IRS shows no sign of backing down from future US disputes. Even in jurisdictions, such as India, where the number of cases are in decline there is an increase in the complexity of the disputes.

The problem is that the heightened scrutiny and exposure that taxpayers face means many challenges are unforeseeable. TP disputes are only going to increase as more countries pursue unilateral action on measures like digital taxation, or decide to reassess the terms of an advance pricing agreement.

“We’re not just dealing with possible disputes over how to apply agreements,” the director said. “It’s about the fundamental concepts of where and how multinationals generate value and profit.”

“Multinationals are looking to articulate how they create value and what taxes they should be paying,” they said. “It’s meant to be fact-driven.”

Instead of a fact-driven process, there is more subjectivity involved in how certain aspects of new TP standards work in practice and this does not help reduce the risks for businesses. Even past deals going back decades are up for question.

In the cases of Medtronic and Coca-Cola, the taxpayers have had to defend their interpretation of past agreements with the revenue authorities and, therefore, APAs do not offer the guarantee they once did.

The onus is likely to fall on TP directors in the meantime because of the critical role transfer pricing plays in identifying where value is created and how it should be treated. But the world may be moving away from some of key concepts like the arm’s-length principle (ALP).

One vice president of TP at a tech company suggested that this cuts to the heart of the matter. “Every tax system needs longevity and stability to guarantee certainty for taxpayers,” the vice president said. “If you think the present tax system has longevity, you’re wrong.”

“We need consistency and a wide uptake to ensure consistency,” they added. “Going for a hybrid approach or switching between different models is not going to work.”

Many developed countries are enacting new measures on digital tax, but, at the same time, developing countries are raising their own demands on taxpayers. India has implemented its own equalisation tax to deal with the dilemma of how to tax the online economy. But it is far from alone.

There is a growing trend towards source-based taxation, which may mean many governments erode the ALP in favour of a different approach to profit allocation. Yet this is going on just as corporate tax rates are falling around the world.

“Source-based taxes increase economic inefficiency in the international tax system,” one tax director at a telecommunications company said. “You have to tax things that are immobile and consumers tend to be immobile.”

“This is why some people say corporate tax is dead and we should move to indirect taxes on consumption,” they said. “The problem is this would be regressive.”

The pace of change in international tax has raised more questions for taxpayers than ever before. As tax laws are reformed, the challenge is twofold. The tax authorities find themselves grappling with new rules and taxpayers often lack the precedents they need to prepare themselves for every eventuality.