Proactive engagement with tax authorities and wider ESG considerations
Increased transparency requirements have pushed the management of tax risk higher up companies’ agendas. Juan Ignacio de Molina, Yoshihiro Adachi, and Carlos Serrano of Deloitte explain how corporate governance and cooperative programmes can help.
In recent years, corporate taxpayers have witnessed a substantial renewal of the international tax landscape, which has ultimately led to a greater demand for transparency. Thus, the correct identification and management of tax risk has become a key element in the agendas and protocols of multinational enterprises (MNEs).
This article will analyse one of the areas that is most relevant for the proper management of this risk: the role of corporate governance and cooperative programmes as instruments to prevent transfer pricing disputes in practice.
Historically, the management of the transfer pricing risk was mainly articulated through two instruments (one proactive and the other reactive).
On the one hand, the proactive instrument is channelled through advance pricing agreements (APAs) negotiated with the competent authorities, which are intended to minimise a potential administrative questioning of the prices assigned to related-party transactions. An APA is an agreement with one or more tax authorities that allows the prior determination of a set of criteria to agree on the valuation conditions and methodologies applicable during a specific period.
On the other hand, the reactive instrument is articulated through mutual agreement procedures (MAPs) with other (foreign) competent authorities, as a consequence of a transfer pricing audit previously carried out by one of them.
One of the main difficulties faced by MNEs derives from a potential conflict between two tax systems, so that the same income may be subject to tax in more than one jurisdiction, thus causing a prototypical case of double taxation. To avoid these situations, MAPs are envisaged as a traditional instrument through which tax authorities consult each other to resolve disputes relating to the application of double taxation treaties or other similar international agreements.
The use of both tax procedures aimed at eliminating double taxation is now an essential mechanism in the management of the tax risk of related-party transactions. Their increasing use by MNEs supports this conclusion.
However, in recent years, tax authorities’ identification of tax erosion practices through risk analysis models that optimise the use of the available (and increasingly diverse) sources of information has improved to a large extent. This reflects their willingness to expand their risk assessment systems to determine preliminarily whether the tax strategy followed by a taxpayer justifies an in-depth verification (with the corresponding allocation of resources inherent in the development of a formal procedure of this nature).
In light of this new paradigm of international taxation and in response to the prevailing demand for greater transparency regarding environmental and social impact as well as governance standards, MNEs have gradually located the tax responsibilities at the top of the board’s agenda. In essence, the current state of affairs has made the articulation of corporate governance’s tax policies the starting point of any strategy aimed at managing, in a proactive and comprehensive manner, the exposure of MNE groups in this area.
Therefore, the design and maintenance of adequate internal control mechanisms, including cooperative compliance approaches, is an essential element to achieve the desired financial stability and sustainable growth under the current changing tax environment.
In this regard, it is important to consider all possibilities of proactive interaction with the tax authorities. In particular, enhanced engagement programmes, as part of the instruments based on the collaborative approach, enable taxpayers to better understand tax authorities’ requirements and the current dynamics.
One programme to highlight is the OECD’s International Compliance Assurance Programme (ICAP), a voluntary programme for MNEs and tax administrations to work together in a cooperative risk assessment and assurance process. It is designed to be an efficient, effective, and coordinated approach to provide MNE groups willing to engage actively, openly, and in a fully transparent manner with increased tax certainty with respect to certain of their activities and transactions.
It is important to mention that the ICAP does not provide an MNE group with the legal certainty that may be achieved, for example, through an APA. It does, however, give comfort and assurance where tax administrations participating in an MNE group’s risk assessment consider covered risks to be low risk. Where an area is identified as needing further attention, work conducted in the ICAP can improve the efficiency of actions taken outside the programme (if needed).
Following this line of thought, the European Commission developed the European Trust and Cooperation Approach (ETACA), which aims to facilitate and promote tax compliance by taxpayers based on greater cooperation, trust, and transparency between taxpayers and tax administrations, as well as amongst tax administrations.
Moreover, the purpose is to provide a clear, EU-wide framework for a preventative dialogue between tax administrations and business taxpayers that leads to the performance by the tax administrations of a high-level risk assessment of the transfer pricing policy adopted by large MNEs.
Once again, ETACA’s type of assurance deviates from the legal certainty that may be obtained through other bilateral or multilateral tools – such as a bilateral or multilateral APA, a joint tax audit, MAPs, or arbitration – substantiated by the fact that the assessment of these types of transactions is in line with the features of the programme that aim to be a common high-level risk assessment. Moreover, they are performed in a short and predefined timeframe: the programme has the challenging ambition, to the extent possible, to result in a common risk classification – ‘low risk’ or ‘no-low risk’ – of each covered transaction.
Additionally, several EU countries apply different types of cooperative compliance approaches. In Spain, the Forum of Large Companies aims at creating a collaborative framework for large companies and tax administrations based on transparency and mutual trust, through the knowledge and sharing of issues that may arise in the application of the tax system. The transparency reports presented by MNEs make effective the reinforcement of good practices of corporate tax transparency contained in the Code of Good Practices adopted at the Forum of Large Companies.
Likewise, under the environmental, social, and governance (ESG) consideration, the importance of corporate governance is increasing in Asian countries, and tax authorities encourage taxpayers to proactively disclose their tax policies.
In Japan, the National Tax Agency has developed a Tax Corporate Governance programme for large MNEs (about 500 corporations nationwide). The purpose of the programme is to benefit companies and the National Tax Agency by enhancing corporate governance in tax matters. For the companies, enhanced tax corporate governance would reduce the risk of inappropriate accounting at the front line of organisations such as business departments, branches, and factories that would result in tax risk mitigation. In addition, tax authorities would be able to reduce the burden of handling tax audits as the companies with good tax corporate governance have a relatively low need for investigation.
During the tax audit, the tax authority will ask the taxpayer to fill in the Confirmation of Tax Corporate Governance sheet, which includes questions regarding the company’s tax corporate governance.
On November 11 2019, the Australian Taxation Office (ATO) announced the expansion of its Tax Avoidance Taskforce, including three programmes specifically focused on tax risks associated with private groups and high-wealth individuals. This follows increased engagement by the ATO with high-wealth private groups and individuals over the past few years and the move away from specific issue reviews to group-wide reviews with increased expectations regarding corporate and tax governance in the private market.
In particular, these programmes will include an assessment of whether an effective tax governance framework is in place for the private group. Whether there is effective tax governance across the group will require several considerations, including:
The roles and responsibilities of those in charge of accounting, tax, and financial decision making;
Details of the tax reporting process;
The existence of any controls to test the accuracy of reporting; and
The ways that the group addresses tax risk.
Global Reporting Initiative (GRI) Standard
For disclosures, as the GRI Standard included tax items in 2019, the companies would need to consider tax disclosure for the purpose of ESG. This standard includes disclosures on the management approach and tax-specific disclosures.
Although this is one of the guidelines and does not provide legal certainty, it is important for the company to understand the needs of tax and general disclosure as tax transparency is increasing under the implementation of BEPS. Especially with the two-pillar discussion on the tax challenges arising from the digitalisation of the economy, companies need to enhance their tax governance globally to gather information and report to the tax authorities as required.
Under the current scenario, to create value for their shareholders, the company must have a business model committed to tax responsibility standards. Thus, MNE managers must face the challenge of designing (internal) tax risk control mechanisms, ensuring the proper functioning of fiscal compliance programmes, and, above all, articulating the general framework of the MNE’s tax strategy.
In this regard, the role of corporate governance and cooperative compliance programmes, where available, may prevent some tax disputes, increase tax certainty for businesses, and improve efficiency for businesses and tax administrations.
In particular, from an MNE perspective, all the above-mentioned will enable companies to evaluate the corporate governance’s tax policies’ impact and encourage them to look beyond financial parameters alone. MNEs will also be able to demonstrate their sustainability performance and objectives, thus creating long-term value for their stakeholders. Clear reporting and disclosures in this area will facilitate larger investments into companies with higher tax corporate governance metrics.
These conclusions are supported by the results of the 2022 Global Tax Survey: Beyond BEPS, Deloitte’s annual global survey of multinationals. In early 2022, Deloitte conducted its ninth Global Tax Survey to understand how large multinational organisations view the global tax landscape and how it has evolved. In this latest survey, Deloitte was interested in the respondents’ views on the topics that were high on their agenda in 2022, such as tax governance and the adoption of the voluntary tax transparency standards.
Tax governance remains high on board agendas
Concern about the media coverage, and political and activist group interest in corporate taxation has remained consistently high over the years (77% of respondent groups are concerned, a gradual increase from 2020). Moreover, 85% of respondents still expect an increase in stakeholder interest in tax behaviour and outcomes over the next three years.
The majority of boards continue to be actively involved in tax governance (66%), although this has dropped from 2021, which is surprising given the growing level of concern. Many groups (41%) are interested in engaging in cooperative compliance frameworks with tax authorities, where these are available, and 18% have already joined, or are in the process of joining, such a programme.
Voluntary tax transparency standards are increasingly being adopted
In response to the increased public interest in corporate taxation, groups are increasingly volunteering more disclosures of their tax affairs, with 33% of respondents expecting to increase their level of voluntary tax transparency over the next year. A total of 60% of respondents expect their group to align its external communication in relation to its tax performance with a transparency standard, with GRI 207 and the World Economic Forum tax metric being the most popular (27% and 20%, respectively).
A group tax transparency strategy is becoming increasingly common among multinationals – 42% of respondents have such a strategy and have tested it with senior leadership, and 55% either already have a tax transparency strategy or expect it to be set up within 12 months.