Surge in data analytics enhance efficiency of transfer pricing audits
Eric Lesprit, Mariusz Każuch and Howard Osawa look at three national case studies and consider whether the increased use of international data improves cooperation among tax administrations.
Information is a key input that enables tax administrations to manage their interactions with taxpayers with respect to both the selection of tax returns for audit, and the conduct of audits that are initiated. Over the last few years, tax administrations have secured expanded access to relevant taxpayer data through various local, regional, and global initiatives. This has in turn enhanced the tax administrations' ability to enforce compliance with local corporate tax and transfer pricing (TP) requirements. Indeed, the increased standardisation and wider accessibility of information constitutes a fundamental change in the relationship between multinational enterprises (MNEs) and tax administrations. As tax administrations gain broader access to data outside of their own countries, MNEs will need to be more diligent to ensure that the data presented in different jurisdictions are consistent.
This expansion in information sharing is broadly evident in most tax jurisdictions. Historically, tax administrations primarily relied on information provided by local taxpayers during on-site audits, or obtained through other available sources in the specific jurisdiction, for example, other national governmental agencies. Gradually, by requiring disclosure of additional information on tax returns, tax administrations began to collect relevant information before the audits started. They used this information to select audit targets and to obtain a thorough understanding of the target company before the tax audit began.
More recently, with an increase in technology and the relaxation of international information sharing restrictions, information has become even more accessible across borders. As a result, tax administrations can gain a broader understanding of how multinationals organise their international activities. To further their understanding of such activities, tax administrations began to design questionnaires for foreign treaty partners under the treaty procedures and in accordance with OECD guidance.
Furthermore, due to increased international pressure and the OECD-suggested sanctions, the pace of exchange of information, and the overall quality of the information subject to exchange, improved. The most recent development is the mandatory exchange of information in various areas (rulings, bank accounts, TP), which is intended to ensure that tax administrations can access information more efficiently.
The 2008-2009 global financial crisis and OECD BEPS recommendations accelerated the international roll-out of these mandatory exchange programs, which were already part of the tax landscape in Europe. For example, the Savings Directive designed in 2003 asked information from EU member states with respect to interest paid on a European bank account to a European national. Now, tax administrations have access to a wide range of information: bank accounts information (FATCA and AEOI–automatic exchange of information), TP (CbCR–country-by-country reporting), and even more within the EU with directives on the automatic exchange of non-financial revenues, compulsory transmission of rulings, mandatory disclosure of certain cross-border tax planning arrangements, with DAC6 implementation to come before year end of 2020.
The following country-specific examples describe the tendency of tax administrations to seek greater amounts of data, how international initiatives contribute to a more expansive and more liberal exchange of information, and ways in which tax administrations use the newly available data to improve their ability to administer and enforce tax compliance.
The French Tax Administration (FTA) has always been keen in the use of information. One example of this commitment is a dedicated data mining department, which was created and funded with more than €20 million ($23.6 million) in 2018. Information from this group is used in more than 20% of tax reassessments. The data used by this group draw on information from a number of different sources.
The recent success of various initiatives against international fraud and hidden bank accounts in tax havens has motivated the FTA to request more information from treaty partners. France was a strong advocate at the OECD for enhanced exchange of information rules and increased quality of information, and it supported the application of stronger sanctions when taxpayers failed to meet heightened standards. According to the Minister of the Economy public statement on July 1 2020, an exceptional increase of roughly 30% in tax reassessments in 2019 compared to those in 2018, resulted from extensive use of information obtained from treaty partners, in accordance with international agreements or EU rules.
Indeed, tax auditors have adopted a standard procedure of requesting information from other countries and territories to clarify specific issues identified during an audit, or to validate information already provided by the audited company or individual. It is common for the FTA to refer to the worldwide TP information report and/or the CbC report prior to setting foot on the premises of an audited company.
Moreover, one might expect the tax audit selection grid employed by the FTA to include all relevant information about the international tax situation of the taxpayers. This comprises information provided by other EU member states on a mandatory basis, for example, specific international transaction rulings that have been granted, unilateral rulings gained in one country, advance pricing agreements (APAs) provided, and so on. A review of such information, in conjunction with other elements obtained through local sources, may increase the possibility that the company will be selected for a tax audit. A similar practice can be anticipated to develop in other European countries:
In Spain, information from foreign treaty partners is typically included in the 16 risk factors analysis considered in the automated pre-audit investigation. This internationally-sourced information is also used in the annual audit plan to select taxpayers to be audited in the coming year.
The German tax administration has designed a tool to perform CbCR data analytics and specialised international tax auditors have been trained to best use of these data. Although it is still at an early stage, this analysis appears to include a comparison of important data points, combined with qualitative information on functions performed.
Similarly, the Italian tax administration is using information gathered from treaty partners to select taxpayers for audit. Moreover, although it lacks a formal agreement for mandatory exchange of information, Italy has participated with Germany in a limited number of joint tax audits, which is another efficient way to gather information on a timely manner.
Based on these observations, it seems that the tendency for tax administrations across Europe to obtain and utilise international data for use in audit selection and in examinations is increasing.
Poland started to work on the active use of available taxpayer information a few years ago, when the decision was made to create a central repository of taxpayer information. This tool already allows for the implementation of advanced IT-based analysis, permitting automated detection of risky behaviour on the part of taxpayers. This became feasible after the introduction in 2019 of the new TPR form, which specifically addresses intra-group transactions. The TPR form focuses on separate transactions that exceed given thresholds, for example two million Polish zloty for services transactions and 10 million Polish zloty for tangible goods transactions, and this may be viewed as the initial step toward the introduction of operational TP in Poland.
Taxpayers are obliged to provide detailed information concerning each transaction, including, among other items: the type and value of the transaction; the TP method applied and the results of the analysis; the jurisdiction where the counterparty is located; the value of TP adjustments; the expected profits of the taxpayer and the counterparty. The accuracy of the information provided on this form is ensured because the management board must sign an annual statement that all transfer prices of the Polish company are arm's-length, which also commits the management board member to a high level of personal responsibility.
It should be noted that in many cases the data provided on the TPR form have allowed the tax authority to identify questionable transactions for additional, in-depth scrutiny. It is expected that the TPR form data, together with other sources of information, will be actively used by the tax administration for purposes of risk analysis and audit selection. At the same time, since Poland is historically a country where many routine subsidiaries of foreign companies are located, the CbC reports seems to be of relatively less utility for the tax authorities. Fiscal auditors often focus on loss-making routine companies, where simple application of the TNMM may result in a positive assessment for such companies. In such cases, the proper allocation of residual profit, which generally belongs to the foreign principal company in any event, seems to have less importance for the authorities.
This situation may change in the near future, if the tax authority concludes that some of these 'routine' subsidiaries have developed their own know-how, and have become recognised in the market because of their own qualities and capabilities, and not solely due to association with a multinational group. In that event, the focus of the tax authorities may shift to the correct allocation of residual profit, and CbC report data may become more relevant.
The DAC6 directive is a reporting tool that has already been implemented in Poland. The Polish implementation of the directive appears stricter than the original language of the directive, and the Polish implementation also introduced a number of local features, not connected to the prevention of tax avoidance schemes. For example, a dividend payment is considered a reportable scheme under DAC6.
From a TP perspective, it is notable that the DAC6 TP hallmarks are included in the directive. Nevertheless, for local tax administration, the adoption of the DAC6 directive appears to be less useful than the use of the TPR form, which requires similar information, but in greater detail. Under these circumstances, it appears that the Polish tax authority may rely on the TPR form as a more effective source of information for audit selection.
Transfer pricing enforcement in Japan continues to be a key area of focus for the National Tax Agency (NTA), and the importance is rising as the increased transparency of international transactions highlights the significant role that TP has in these arrangements. Historically, TP arrangements have been reviewed by reference to information, data and schedules included in the corporate tax return. Recent initiatives for sharing of information globally have provided additional information sources that the NTA and the field examiners of the Regional Taxation Bureaus (RTBs) can access when evaluating the cross-border transactions of Japanese taxpayers.
For matters relating to TP, the information return, Form 17(4), which is included in the corporate tax returns, provides the basic information from which the tax administration may assess the pricing of inter-company transactions. Among other things, Form 17(4) provides a broad overview of the scale, nature and scope of the inter-company transactions involving a Japanese taxpayer, including information regarding the related parties with which it engages in transactions, the type of transactions (e.g. tangible goods, licensing arrangements, services, or financial arrangements), the amount of those transactions, and the method used to price those transactions. A review of this information, which may include a review of whether the taxpayer engages in transactions with related parties in tax-haven or low-tax jurisdictions, or in transactions involving licenses of intangible property or inter-company services, may generate attention from the tax administration. Persistent losses or significant changes in profits from year to year, including declines in profit, may highlight problems in TP that may trigger an audit.
The NTA and RTBs continue to rely on traditional sources of information available through the corporate tax returns, even as additional and new information made available through the mandates of the international tax community provide new and more granular information concerning potential tax risks. While the common reporting standard (CRS) and adoption of the AEOI identify possible instances of tax evasion, for TP matters specifically, the information exchange programs of tax treaties and OECD BEPS TP documentation mandates provide the primary source of new information.
With respect to information exchange under existing treaties, the NTA estimated in its 2019 report that in nearly 300,000 cases, information was exchanged among treaty partners in 2013, and over 800,000 cases in 2017, including cases relating to the AEOI and the CRS. These statistics indicate a significant increase in the flow of information between Japan and its treaty partners, suggesting that the tax authority continues to obtain additional transparency with respect to international dealings of multinational enterprises.
The BEPS TP documentation mandates adopted by Japan allow further transparency concerning international dealings. The automatic exchange among treaty partners of the CbC report provides tax administrations additional data that contribute to the increased transparency of international transactions. The NTA estimates in its 2019 report that it received approximately 550 CbC reports from foreign tax administrations, and itself provided approximately 600 CbC reports.
As the NTA and RTBs have historically expressed an interest in the global application of TP principles, the CbC report helps the administration to assess the correct application of an MNE's TP policy. While the NTA has not explicitly shared how it uses such data to identify audit targets, or how such data should be used in actual audits, it may be expected that the data from the CbC report, as well as information from the master file, constitute extremely useful information when assessing TP compliance.
In this sense, together with exchanges of information made available through treaty protocols, the NTA and RTBs have available to them a wealth of information that allows them to evaluate a taxpayer's inter-company transactions. For the taxpayer, this suggests a need for higher diligence in developing, implementing and documenting group TP policies in order to ensure local compliance with the information and data that is now available globally.
Tax administrations historically relied on various sources of data to assess the compliance of taxpayers with local rules and regulations. We see the evolution for the need to have access to more and more data and to better anticipate that sharing of information, through various initiatives introduced from a local and multi-jurisdictional perspective as the focus on international dealings and instances of tax avoidance become more public.
The OECD mandates put forward through the BEPS project have been adopted almost universally by tax administrations, and the recommendations have contributed to a proliferation of data now made accessible to them, under a mandatory sharing as a large part. Together with the focus on international dealings, and the related focus on increased transparency, the new data provide additional resources from which tax authorities may evaluate TP and international tax compliance.
In the three main cases above, we see evidence of the increased use of international data and improved cooperation among the tax administrations to ensure an equitable distribution of income globally. One consequence of this is the need for MNEs to ensure consistency in the explanation of the international tax positions of taxpayers and the presentation of data, and specifically in the execution of TP policies.
For transfer pricing, with tax administrations now having access to a significant amount of data that can be used to assess whether the policies and implementation of policies are applied reasonably throughout the organisation, consistent implementation and appropriate documentation of the inter-company transactions becomes more and more critical.
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Eric Lesprit is the former head of the APA and mutual agreement procedure (MAP) French programme, dealing with elimination of double taxation for the FTA.
Eric participated in the design and creation of the APA program in France in 1999. He negotiated and concluded the first French APA and many other agreements since then, including the first multilateral agreement. He has worked in particular with tax administrations of the main economic partners of France, including most of the European countries (UK, Germany, Spain, Italy, Belgium, Netherlands and Ireland), as well as the US, Canada, Japan, South Korea and Singapore. He has built trust and a close relationship with these administrations.
Eric had more than 15 years of experience in TP and international tax at the FTA before joining Deloitte/Taj. He headed the French APA program from 2008 to 2015. In 2013, he created the new French competent authority, merging the APA program and the MAP within a single department which he led.
Eric is regularly consulted by the French parliament about international tax matters. He is a frequent speaker in various conferences and a recurrent author of articles regarding international tax and TP aspects.
T: +48 662 288 424
Mariusz Każuch is a partner associate in Deloitte's TP team in Poland. He is responsible for the supervising and coordinating Deloitte Poland's APA and MAP proceedings. He is involved in numerous controversy cases for multinationals operating in various industries including automotive, banks, energy and entertainment.
Mariusz is a certified tax advisor. Before joining Deloitte, he was the deputy director of department in the Polish Ministry of Finance in 2016-2017, responsible for TP, MAP and APA negotiations, policy and legislation.
Mariusz has supervised the process of negotiation of more than 50 international agreements, including 36 double taxation treaties. He is an author of the special petroleum fiscal system in Poland and co-author of the copper and silver extraction tax law. He has participated in many fiscal projects, i.e. training for Zambian and Kenyan tax authorities in scope of tax policy for the extraction of mineral resources.
T: +81 0 70 1473 8951
Howard Osawa is a partner in the TP practice of Deloitte Japan. He has more than 20 years of experience in TP and has worked in both Japan and the US. More recently, he has also served as the Japanese country leader for the customs and trade practice of a large professional services firm.
Howard has supported a number of multinational companies operating in Japan, and has provided assistance to them on a variety of TP matters. He has helped companies with APAs, audit defense, documentation, and value chain alignment. His clients have included companies in the consumer, energy, health and beauty, and specialty chemicals sectors among others.
Howard also uses his TP experience to assist companies with customs and trade planning, documentation and audit support. In this regard, he has experience supporting companies in the areas of customs valuation, establishing and documenting new inter-company arrangements and agreements, and supply chain planning.