Taxpayers in today's global tax environment are facing a myriad of challenges that are in turn creating increased uncertainty. The source of these challenges is primarily attributed to enhanced enforcement actions by tax administrations, such as engaging in aggressive audit and examination tactics, implementing unilateral measures that diverge from international standards, promulgating transparent reporting requirements, and developing robust risk assessment tools. This is resulting in an ever growing proliferation of cross-border audits and disputes, placing further pressure on the resolution of treaty-related disputes, and increasing the risk of double taxation.
Heightened risk and uncertainty may generate taxpayer interest in cooperative compliance programmes as well as private rulings and advance pricing agreements (APAs). It is uncertain, however, whether these dispute prevention and resolution mechanisms will be effective and efficient, thereby providing relief from double taxation – particularly if relevant stakeholders are not incentivised to engage in a cooperative and collaborative process providing definitive and conclusive results.
In this environment, there is a pressing need for global consensus on mandatory binding arbitration – ideally the last-best-offer (baseball style) decision-making approach – to encourage countries to resolve disputes before a case is presented to an arbitration panel. This would foster the certainty that is needed in today's tax controversy environment. But, the reality is that countries have divergent views on the need for mandatory binding arbitration and on the particular decision-making approach to employ. Accordingly, stakeholders will likely continue to face a challenging landscape in the global tax environment.
Enhanced enforcement actions
A number of forces have developed and converged to create new challenges for taxpayers and other stakeholders worldwide. Developed nations and increasingly emerging countries, continue to engage in aggressive tax audits and enforcement actions with an eye toward increasing revenues to address budget gaps and other revenue needs. In certain countries, 'tax raids' are increasing along with allegations of criminal tax violations and the threat of bad faith penalties against multinational companies (and company executives), thereby resulting in increased reputational risk and other uncertainties. Multi-country 'simultaneous audits' are also increasing – a process that is intended to result in better cooperation between tax administrations, but unnecessarily creates challenges for taxpayers responding to examinations on multiple fronts and uncertainty with respect to whether the governments involved can achieve an amicable resolution avoiding multiple treaty-related disputes that end up in the mutual agreement procedure (MAP) process.
Moreover, a number of countries have implemented unilateral measures – from the promulgation of new legislation or policies and procedures, to intensified audit activity, to other measures – all intended to address base erosion and profit shifting (BEPS) and to protect their individual financial interests. Some of these measures appear to depart from internationally accepted standards, including many of the OECD's recent recommendations. This results in a lack of consensus, the potential for an increase in audits and disputes worldwide, and additional strain on dispute prevention and resolution alternatives. The MAP programme is already under immense pressure, as evidenced by the MAP statistics released by the OECD, with the most recent results showing an overall increase of 163% in pending cases for the period between 2006 and 2015. Unfortunately, there are few signs that a dramatic reversal in these record high levels of pending cases is on the horizon.
The state aid cases are another troubling development for taxpayers, creating uncertainty for multinational companies that entered into tax rulings and APAs originally thought to comply with international norms. The European Commission's state aid investigations call into question the validity and the resultant predictability that those rulings were intended to achieve. In addition, the diverted profits tax (DPT) legislation in certain countries only further increases risk and uncertainty for corporate taxpayers. State aid investigations and DPT cases aside, uncertainty has also increased as a number of governments have stepped back from private rulings and APAs, disengaging from previously agreed positions thought to protect taxpayers against future audits, risks, and exposures.
These collective actions undermine the need for mutual cooperation and multilateral coordination in addressing tax avoidance and the need for certainty for taxpayers and tax administrations alike. Such actions will inevitability result in increased audits, treaty-related disputes, and the risk of double taxation. These challenges are further compounded by a new era of global transparency based on increased reporting requirements and the automatic exchange of information along with enhanced risk assessment tools.
Global transparency and risk assessments
Enhanced tax transparency is one of the fundamental pillars of the OECD's BEPS initiatives, accomplished in part through the OECD's BEPS Action 13: "Transfer Pricing Documentation and Country-by-Country Reporting" (CbCR) deliverable, taking disclosure requirements and the automatic exchange of information to new levels. Countries have also issued domestic legislation implementing the CbCR measures further amplifying uncertainty for taxpayers. Moreover, not all countries have signed onto the agreement relating to the exchange of CbCR and to other related agreements. Many countries intend to execute bilateral competent authority agreements with specific treaty partners or information exchange agreements to ensure CbCR data is automatically exchanged. There is a risk, however, that if countries do not sign these agreements, then the secondary mechanism will apply and companies may be required to file the CbCR with certain local jurisdictions. Tracking the fluid implementation of such legislation and the automatic exchange mechanisms has become an administrative burden for taxpayers, creating uncertainty related to compliance requirements and related penalties for failure to comply.
The disclosure of the global allocation of income, taxes paid, and economic activity via the CbCR, along with the master file and local file, is intended to serve as a risk assessment tool for tax administrations. These filing requirements will provide more detailed information from which tax administrations can perform data analytics and identify risks. The data, however, may be susceptible to misunderstanding and misinterpretation by tax administrations and correspondingly result in unnecessary audits, particularly in the early years of the roll-out. The International Compliance Assurance Programme (ICAP) pilot is designed to assist countries with processing the CbCR data and coordinating multilateral cooperative risk assessments, initially by a limited number of tax administrations working with eligible multinational groups willing to engage in an active, open, and transparent manner. The end goal is to confirm the risk status of taxpayers related to the covered risks by each of the participating tax administrations, thereby providing tax certainty to those companies. There remains a number of issues and concerns with the implementation of ICAP. These include whether certain key risk areas may be isolated for separate treatment through alternative dispute resolution options that may not provide the level of certainty taxpayers aim to achieve through the ICAP pilot.
Transparency is at the forefront of today's global tax environment as one of the driving forces to enhance risk assessment approaches and to prevent tax avoidance by multinational groups. But at the same time, transparency is causing uncertainty for taxpayers in complying with the CbCR requirements and in understanding whether the reporting of such information will subject taxpayers to an increased number of audits and disputes. While the ICAP pilot is intended to provide a level of tax certainty, it is unclear whether the pilot will be successful in developing support for full implementation. The reality is that enhanced tax reporting requirements, transparency, and the sharing of taxpayer information will inevitably lead to an increasingly contentious audit environment and may increase the stress already placed on the MAP process, leading to further cross-border disputes and the risk of double taxation.
Dispute prevention and resolution mechanisms
The challenges and increasing uncertainty in the global tax environment require improvements to the dispute prevention and resolution process. Many stakeholders are frustrated with today's dispute resolution system that, in many cases, provides no definitive or conclusive way for quickly resolving cross-border disputes. This results in prolonged controversies and may lead to inequitable results. The OECD's BEPS Action 14: "Making Dispute Resolution Mechanisms More Effective" is aimed at minimising the risks of uncertainty and double taxation by ensuring consistent and appropriate implementation of the MAP process under bilateral tax treaties. In this connection, countries are tasked with developing 'minimum standards' in the context of treaty-related disputes and ensuring effective and efficient implementation of those standards through the establishment of a peer-based monitoring process. The Forum on Tax Administration, along with the OECD's Working Party No. 1 on Tax Conventions and Related Questions, developed the peer-based monitoring process, which is currently in the implementation phase. It is unclear, however, if the peer review process, standing alone, will hold tax administrations to the level of transparency needed to ensure dispute resolution mechanisms are indeed more effective and efficient. Many observers believe that the adoption of mandatory binding arbitration will provide the relief needed for taxpayers in a contentious treaty-related dispute and, correspondingly, provide more certainty that taxpayers will achieve timely resolution of controversies and not be subjected to double taxation.
Specifically, the mandatory binding arbitration process should guarantee that treaty-related disputes are resolved within specified time frames. Although numerous countries have committed to providing mandatory binding arbitration in their bilateral tax treaties, unfortunately a number of important G20 countries have not yet committed to this important dispute resolution alternative. Further, for those countries agreeing to implement mandatory binding arbitration, they are allowed to adopt either the last-best-offer approach ('baseball style' arbitration) or the 'independent opinion approach'. The latter option relies on arbitrators not being bound to the position offered by either of the competent authorities, and instead, are allowed to determine a compromise or middle ground solution. The former 'baseball style' approach – and notably, the default option, as proposed recently by the OECD – in the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the MLI) – is arguably the best solution because it incentivises competent authorities to set forth reasonable positions, which in turn should encourage settlement of cases during the competent authority negotiations before the case is ever presented to an arbitration panel. The uniform acceptance of the 'baseball style' mandatory binding arbitration via the MLI is a critical step forward in ensuring that treaty-related disputes are resolved in a timely, effective, and efficient manner, thereby alleviating the risk of double taxation.
Today's global tax environment is an increasingly complex maze in which taxpayers face new challenges in virtually every corner of the globe.
The OECD has made strides in issuing guidance that is built on generating more transparency and attempting to improve dispute resolution mechanisms. Unfortunately, this approach has created even more challenges for taxpayers around the world.
The reality is that enhanced enforcement actions, new reporting requirements, automatic exchange of information, and multilateral risk assessment processes will lead to increased audits and disputes, creating new challenges and corresponding uncertainty for taxpayers.
Moreover, dispute prevention and resolution mechanisms, such as private rulings and APAs intended to provide certainty to multiple stakeholders, are now under pressure.
Accordingly, implementing the minimum standards under Action 14 and achieving consensus on the adoption of mandatory binding arbitration are now more important than ever. Indeed, mandatory binding arbitration is one of the keys to bringing certainty in an uncertain global tax environment.
Unfortunately, serious work remains to be accomplished in order to garner widespread adoption of mandatory binding arbitration, and, in particular, the baseball style approach to arbitration that is needed to create real change for the benefit of all stakeholders.
| David Swenson