Enhanced tax transparency, tax efficiency, and improved tax dispute resolution mechanisms are driving themes in today's global tax landscape, given the promulgation of new disclosure requirements and automatic exchange of information at the centre of agendas of both governmental and non-governmental organisations. The OECD's country-by-country reporting (CbCR) template, recommended in Action 13 of its base erosion and profit shifting (BEPS) project, is significantly impacting how multinational enterprises (MNEs) look at the tax function within their organisation, and is generating concerns over the public disclosure of reported data. There is also uncertainty over how the data will be interpreted by tax authorities from a risk assessment perspective, and the potential for an increase in audits and disputes worldwide.
At the same time, the European Commission's state aid investigations into certain rulings received primarily by US-based MNEs, and the Commission's recent decision to require Apple to retroactively pay $14.5 billion in unpaid taxes, are also causing chaos in the global tax environment – creating even more uncertainty for MNEs that obtained tax rulings originally thought to be in compliance with international standards. Moreover, these state aid investigations have been questioned as undermining the OECD's efforts to reduce tax avoidance through its BEPS initiatives, including CbCR, and thereby leading to a new era of global tax transparency and increased controversy.
Tax transparency – dawn of a new era
Transparency is one of the fundamental pillars of the OECD's BEPS initiatives, partly accomplished through the OECD's BEPS Action 13 on the Transfer Pricing Documentation and CbCR.
Action 13 recommends a three-tiered approach that includes a master file, a local file, and a CbCR template for multinationals to report income, taxes paid, and economic activity on a country-by-country basis that will collectively move disclosure and transparency for tax administrations to new, unprecedented levels.
Standing alone, the disclosure of the global allocation of income, taxes paid, and economic activity via the CbCR initiative is intended to serve as a 'risk assessment tool for tax authorities'. Tax authorities will, however, view the master file and local file in parallel with the CbCR to rationalise the CbCR results as a beginning point in deciding whether to initiate a transfer pricing audit.
The consequential effect is that the three filings will enable tax administrations to use the reported information to perform data analytics, identify transfer pricing risks, deploy resources to more effectively assess such risks, and commence audits with more information on hand.
Unfortunately, the data may be susceptible to misunderstanding and misinterpretation by tax administrations and other stakeholders. The end result will likely be a more volatile audit and dispute environment.
Numerous countries have promulgated domestic legislation implementing the CbCR measure, which will be automatically exchanged between jurisdictions through the multilateral Convention on Mutual Administrative Assistance in Tax Matters, bilateral tax treaties or tax information exchange agreements (TIEAs), or other government-to-government mechanisms, such as the Multilateral Competent Authority Agreement (MCAA) on the exchange of country-by-country reports.
In addition, the European Commission has announced proposals that would require the public reporting of CbCR, which is now back in the spotlight following the Commission's recent decision to require Ireland to retroactively recoup $14.5 billion in taxes from Apple. According to the Commission, public reporting of employees, activities, turnover, and taxes paid will provide greater transparency into the tax arrangements and agreements between MNEs and governments in Europe.
EU state aid cases – increased uncertainty in MAP cases
Separately, the Commission's Apple decision may increase uncertainty for MNEs that have obtained tax rulings and advance pricing agreements that were previously thought to comply with international norms.
BEPS Action 13 requires a listing of such rulings and agreements within the master file (and in fact, a copy as part of the local file) as a means to provide enhanced transparency. But, the European Commission's state aid investigations go one step further in questioning the validity of transfer pricing principles agreed upon between MNEs and governments. The Commission's interpretation of the state aid doctrine and retroactive recoveries could undermine mutual cooperation and multilateral progress in addressing international tax avoidance through the OECD's BEPS project, and, in turn, could create a divide in the architecture of the new international structure that is meant to be predictable, fair, and efficient.
The mutual agreement procedures (MAP) process under bilateral income tax treaties is one of the primary mechanisms through which cross-border tax disputes are resolved. Unfortunately, due to disagreement over the application of certain international norms, the European Commission's approach in state aid matters may lead to audits and controversies that are difficult or impossible to resolve through the MAP process. If this concern materialises in practice it will lead to more uncertainty and potentially to an increase in double taxation in bilateral cases around the world.
The bottom line is that these increased tax reporting requirements and the sharing of sensitive data and information, along with state aid investigations that call into question the validity of long-standing international standards, on a collective basis may inevitably result in a new era of tax controversy leading to an increase in the number and size of audits and disputes and a far greater risk of multiple taxation of the same items of income.
Managing risk in the new era of global tax controversy
Pre-emptive measures, such as performing 'strategic risk assessments' as part of the process of compiling the information to be reported through BEPS Action 13, will become a key component of a broader, coordinated approach to preventing and managing audits and disputes worldwide and will become a necessary and essential part of risk prevention strategies. This will necessitate a holistic approach to enhancing the compilation, sharing, and documentation of data that necessarily includes technological solutions. Re-allocation of resources to a centralised hub for audit and controversy functions will also become critical in developing and maintaining consistent defensive strategies on a global basis, as well as in monitoring the resolution of audits and assessing the potential impact that disputes may have on overall results.
In certain circumstances, pre-audit strategies (such as early communications and negotiations with tax authorities) can provide certainty for taxpayers and correspondingly reduce the risk of future audits and disputes. These alternative resolution options do not, however, address the fundamental concern that increased reporting requirements and exchange of information will create widespread transparency into the business activities of MNEs for tax authorities worldwide – with governments each performing their own independent risk assessments, initiating audits, and assessing income and tax adjustments. As a result, the risk of double (or even multiple) taxation will be compounded and exponential pressure will continue to be placed on the MAP process. Moreover, the European Commission's state aid investigations will add an additional layer of complexity into the resolution of treaty-related disputes through MAP. EU member states may find it difficult to comply with their obligations under bilateral tax treaties to provide relief for double taxation through MAP with respect to a state aid decision, given that the interested treaty partners would not be part of the European Commission's decision, and accordingly, may lack the fundamental framework through which a treaty-related dispute can be resolved.
Making dispute resolution mechanisms more effective
The OECD's BEPS Action 14 on 'Making Dispute Resolution Mechanisms More Effective' is aimed, in part, at minimising the risks of uncertainty and double taxation by ensuring consistent and appropriate implementation of the MAP process under bilateral tax treaties. The final report provides that countries will commit to developing 'minimum standards' in the context of treaty-related disputes and will ensure effective and efficient implementation of the standards through the establishment of a peer-based monitoring process. The minimum standards are complemented by a number of best practices designed to meet three guiding principles, namely:
- Ensuring that treaty obligations relating to MAP are fully implemented in good faith and that MAP cases are resolved in a timely manner;
- Ensuring implementation of administrative processes that promote the prevention and timely resolution of treaty-related disputes; and
- Ensuring that taxpayers have access to MAP when eligible.
Moreover, the OECD has indicated that 20 countries have committed to providing mandatory binding arbitration in their bilateral tax treaties as a means to guarantee that treaty-related disputes are resolved within specified timeframes. This has been considered a remarkable move forward as collectively these 20 countries were involved in more than 90% of outstanding MAP cases at the end of 2015. Nevertheless, concerns remain that a number of important G20 countries have not yet committed to mandatory binding arbitration and the increase in the global MAP case inventory in future years may be largely attributable to those countries.
The final report clearly reflects a deep understanding of the difficult problems faced by, and some potentially created by, tax administrations as BEPS initiatives are implemented – problems that can only be addressed on a multilateral basis with full accountability and transparency. To this end, additional work on the formation and implementation of a peer monitoring mechanism is deemed critical and necessary to ensure that the minimum standards were in fact satisfied.
The MAP Forum within the OECD's Forum on Tax Administration, along with the OECD's Working Party No. 1 on Tax Conventions and Related Questions, have been given the directive to develop and implement a peer review mechanism. Over the course of 2016, progress has been made in developing this mechanism with the aim to implement the peer review process towards the end of 2016, and with the first reviews being delivered in 2017 to the OECD Committee on Fiscal Affairs. The core documents for the peer monitoring process will include 'terms of reference' and the 'assessment methodology' that will include a roadmap upon which committed countries will be assessed along with ensuring that assessments across all countries will be consistently applied. Thus, tax administrations also will be held to a new level and different types of 'transparency' in handling cross-border disputes and MAP cases.
Transparency is at the forefront of today's global tax environment as one of the driving forces to prevent tax avoidance by MNEs.
The reality is that increased tax reporting requirements and the sharing of information will inevitably result in an increased number of audits and disputes that will further stress the MAP processes and will increase the risk of double taxation.
Separately, the European Commission's state aid investigations show no signs of slowing down and will add a layer of complexity to increased tax disputes.
Hence, the OECD's work on BEPS Action 14 is an integral component of the overall BEPS initiatives – the success of which will depend on responsible tax administration through a commitment to the minimum standards and cooperation in the peer monitoring mechanism.
In this dynamic global environment, MNEs are encouraged to adopt a proactive strategic approach to considering the structure of the tax function in the tax controversy space, with a view to enhancing the ability to prevent, manage, and resolve tax audits and disputes worldwide.
|David Swenson, PwC|
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