The resolution of tax-related disputes between jurisdictions feels like an unreachable goal in today’s climate of complex audits and long mutual agreement procedures (MAPs), according to speakers at ITR’s virtual Managing Global Tax Disputes Summit 2020 and the ITR Tax Controversy Summit 2020.
BEPS Action 14, which seeks to improve how cross-border tax disputes are resolved between jurisdictions, has not yet delivered on its promise. Rather than quickening the process, the length of time to conclude a MAP has increased for transfer pricing (TP) matters, according to the OECD’s MAP statistics.
Sarah Blakelock, former consultant at Slaughter and May, who specialises in tax dispute resolution, says that some multinational enterprises are choosing not to use MAPs or arbitration because it is “too early to know whether the BEPS minimum standards in Action 14 are operating effectively.
Nevertheless, she points out that “revenue authorities are increasingly releasing guidelines and other publications on how taxpayers can access a MAP, as well as advanced pricing agreements and other dispute resolution procedures, including how domestic remedies apply in conjunction with MAP”.
Managing TP arrangements and benchmarking studies
The complexities of Action 14 was just one of the topics of conversation and debate at the ITR’s virtual Managing Global Tax Disputes Summit 2020. A key area of focus was minimising the risk of disputes and dispute prevention, with a focus on how to use advance pricing agreements (APAs) in an economic climate that has been adversely affected by COVID-19.
For some, how to manage TP arrangements and benchmarking studies effectively is a real concern because of the significant and unusual losses some companies are making in 2020, compared to previous years.
MNEs are using 2018/19 comparables right now, but transactions made today are tomorrow’s comparables, meaning the impact of bad financial results in 2020 could have a ripple effect into 2021 and 2022 and significantly impact TP arrangements.
“You’ll see the impact in the comparables, but the problem is the timing. You would normally get the financial results for 2018/19 around this time,” says Enrique Guzman, transfer pricing manager at Hitachi Europe. “My comparables are all profitable right now, but 2020 comparables are all going to have losses. It’s going to be difficult.”
In particular, digital consumer-facing companies with hard-to-value intangibles (HTVI), such as visual effects software, are preparing for TP challenges as countries begin looking to recover tax revenues.
It is increasingly challenging to verify prices and margins for hard-to-value intangibles such as software because of repeated fluctuations in market demand, particularly during the COVID-19 pandemic, which has shifted pricing models.
Benchmarking studies on these products that face a lag in relevant, available market comparables are expected to be easy targets for tax authorities to challenge in order to raise tax revenues.
“There are key questions on business models that were not there in 2008. I don’t know how some of the digital, consumer-facing companies will catch the effects of COVID-19 following changes to their benchmarks,” said one global head of tax at a media company.
“Finding proper benchmarks is important especially on visual effects where the industry is moving so fast,” he added.
These difficulties are raising concerns among tax directors that there will be more audits in the coming years.
Joint audits to rise
Many anticipate more aggressive audits as tax authorities try to plug the revenue gap left by governments spending more to manage the effects of COVID-19. However, some tax authorities say it is joint audits that tax functions should be preparing for.
“I think the appetite for joint audits will be even bigger,” says Eva Oertel, legal counsel at the international tax department at the German Finance Ministry, while discussing the likelihood of more joint audits after the COVID-19 pandemic ends.
The global economy is so integrated that joint audits might become more widespread in the future. Tax authorities cannot solve every case in isolation from other countries, especially when it comes to transfer pricing matters. “Global challenges need global solutions,” says Oertel.
Although joint audits are becoming more popular across the EU member states, taxpayers and advisors say the US will keep things traditional when it comes to dispute prevention.
“I don’t see a lot of joint audits taking place in the US,” says Brian Gleicher, head of the US transfer pricing practice at White & Case. “What I do see in the US is a lot of advance pricing agreements.”
Renegotiating APAs
The continuing viability of an APA is at risk if either its conditions are not met, or the critical assumptions of the agreement are questioned.
Advisors say tax authorities are looking at force majeure clauses to maintain APAs on a case-by-case basis depending on the contractual language and domestic legal interpretation of the clause, especially in granting tax relief under the pandemic.
However, tax directors intend to revise force majeure clauses in APAs and inter-company contracts after finding limited certainty on deferring certain contractual obligations and maintaining agreements under the clause amid the pandemic.
Mark Martin, tax partner and TP lead at KPMG US, said that some taxpayers may find that they have “flexibility to adjust pricing policies to respond to unforeseen circumstances, or that a force majeure clause provides an exit, while others may realise they have locked themselves into a result that no longer makes economic or business sense”.
On the other hand, some taxpayers may find their APAs are not well suited to the COVID-19 business reality because their network of limited risk distributors cannot effectively manage the redistribution of losses during the pandemic.
The tax certainty once offered through an APA to manage the TP risks has diminished considerably since the pandemic struck the profits of global businesses. As such, establishing a strategy that has the ideal combination of tax risk management, governance and transparency is important, although a constant challenge for taxpayers. Getting this wrong can lead to tax controversy.
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