By Bill Millar
Businesses that find themselves locked in a dispute with tax authorities today face this statistic: the number of unresolved mutual agreement procedure (MAP) cases has grown 163% since 2006, according to the Organisation for Economic Co-operation and Development (OECD).
MAP cases arise in situations where two or more parties are unable to reach an agreement following an audit and subsequent negotiations.
The increasing number of MAP cases — they rose by 14% in 2015 — provides an indication of the degree to which tax disputes are rising, according to Paris-based Jeffrey Owens, Senior Tax Policy Advisor at EY.
As tax controversy rises across the world, so does the need for more effective dispute resolution mechanisms, especially across borders.
“I believe there will likely be more competition between different national tax authorities.“
Morrie Cheng, VP for Asia Tax at MetLife
Worse before better
Transfer pricing itself accounts for 80%–90% of current tax disputes, says David Canale, Washington, D.C.-based EY Global & Americas Leader, Transfer Pricing Controversy Services.
While different plans are underway to improve these mechanisms, including through the OECD’s base erosion and profit shifting (BEPS) project, it will take time to implement them broadly across the world.
“With the expected surge in controversy, tax authorities are likely to have their hands so full that resources and focus will be under severe strain,” Canale says. “The reality is that even with these efforts to improve dispute resolution, matters are going to get slightly or even potentially much worse before things overall begin to improve.”
Who gets the tax base?
Today’s volatile controversy environment is being shaped by stricter enforcement, as governments continue to look for new ways to raise revenues.
In addition, the BEPS initiative could lead to more disputes in the years ahead as governments share more information but have different views on a taxpayer’s filing.
“The BEPS rules require a detailed functional analysis requiring specialist knowledge of each company’s business model, plus a series of subjective judgments,” says Sol Picciotto, Emeritus Professor at the UK’s Lancaster University Law School. “Few jurisdictions have the resources to do this for every business; it’s almost a recipe for uncertainty and dispute.”
The local tax dispute of the past will increasingly become global in nature.
Morrie Cheng, MetLife’s Hong Kong-based Vice President for Asia Tax, says that almost all audits today are territorial.
In the next few years, however, Cheng expects that there will be more joint audits involving two or more nations and that those audits would lead to more MAP cases.
“I believe there will likely be more competition between different national tax authorities,” says Cheng.
Indeed, many such audits will not reach a harmonious conclusion, warns Joy Svasti-Salee, a professor and international tax specialist at the Centre for Commercial Law Studies at Queen Mary University of London.
When one country takes a position in an audit and makes an upward adjustment to profit there is a direct impact on another county, and potentially a knock-on effect on other countries where the group is doing business, she explains.
The new country-by-country reporting requirements under BEPS, and the increasing amount of data sharing, means that countries are likely to identify profitable group companies and better focus their transfer pricing inquiries.
“This may result in more disputes with more at stake, including more potential double taxation and increased bilateral litigation, which is not a solution to a multilateral problem,” says Svasti-Salee.
The tax uncertainty is expected to lead to a surge of cross-border disputes which makes it urgent for a clearer and more effective dispute resolution process.
One recommendation prescribes specific improvements to MAP, seeking to resolve MAP cases within a two-year time frame.
To do so, G20 nations and others must join in this convention to subscribe to minimum standards related to dispute prevention, access to MAP processes, resolution of MAP cases and implementation/follow-through on MAP conclusions, in addition to peer review.
Owens believes requiring peer review is compelling.
Each participating tax administration will be monitored and reviewed by all the others who will be able to issue red, yellow or green cards against various criteria.
“For those countries that participate, it should lead them to allocate more resources and work more cooperatively,” Owens says.
We can MAP it out
Not every audit will lead to a successful finding and conclusion. In such cases, the taxpayer has the right to pursue, where available, a mutual agreement procedure (MAP). Also known as a competent authority proceeding, a MAP process involves officials from two or more jurisdictions collaboratively reviewing the facts within a specific multilateral audit. The OECD recommends introducing a range of measures, such as the introduction of minimum standards and peer review, to improve the resolution of MAP cases. This is an important step, since the number of new MAP cases reported each year is on the rise, as is the backlog of unresolved map cases (the latter is up 163% since 2006).
Reluctance in the developing world
The main obstacle is that the countries with the skills and resources, such as Germany, are signing on to the change, while many developing countries continue to hesitate, according to Owens.
Nonetheless, he believes there are incentives for all nations to improve their dispute resolution.
“No one wants a bad business rating, as that can hurt foreign direct investment,” Owens says.
India, for example, is already working more closely with the US to settle a backlog of MAP disputes.
At a special October 2016 working session in Washington, DC, Indian and US authorities concluded over 100 pending MAP cases — many of them long-standing.
Another BEPS initiative aimed at delivering greater certainty prescribes the development of a multilateral instrument that will be used to help harmonize various definitions, treatments and conditions described in global tax treaties.
It is an essential step, as the 15 actions within the BEPS project, including the improved dispute resolution process would require lengthy amendments on a treaty-by-treaty basis without this mechanism.
In late November 2016, over 100 jurisdictions concluded negotiations on this instrument, which will now be used to update more than 3,000 treaties worldwide.
“This will help clarify rules and add greater transparency and consistency that should help to reduce the number of issues up front,” says Canale.
Mandatory dispute settlement
In a world characterized by political and economic uncertainty, governments need to avoid adding tax uncertainty which in turn requires that cross-border tax disputes are resolved quickly and effectively.
This is why businesses and many governments are pushing for mandatory arbitration as a safety net to the traditional MAP process.
So far, 20 nations have committed to binding mandatory arbitration, according to Achim Pross, Paris-based Head of the OECD’s International Co-operation and Tax Administration Division.
He expects more to join in the near future and sign up to the arbitration provision in the multilateral instrument that the OECD recently released.
Here again, the challenge is widespread implementation.
For now, the countries where binding arbitration is most needed are refusing to join, according to Canale.
He cites several possible reasons, including a loss of sovereignty and a lack of faith in the integrity of the existing institutional framework in which arbitration currently takes place.
Avoid court if you can
No matter the jurisdiction, the court system should always be considered the last resort.
“Not only are courtroom proceedings potentially even more drawn-out than other avenues, they also have a tendency to harm a company’s in-country reputation,” says Beijing-based Joanne Su, EY Asia-Pacific Transfer Pricing Markets Leader.
In China, for example, companies rarely choose to go to court, says Su.
“If you do this, you will be viewed as uncooperative and will ruin your relationship with the government.”
The best defense
Prevention is still the best cure, says Canale.
A first step for businesses is to confirm their transfer pricing strategies and practices are up-to-date and fully BEPS-compliant.
If they are called into an audit, they can present their case quickly and confidently.
In fact, the faster a company can answer the questions in an audit, “the better the chance of a timely and reasonable conclusion,” says MetLife’s Cheng.
Cooperative compliance is another tool that taxpayers are using to boost certainty.
For example, large businesses in the US can agree to share information up-front, working collaboratively with the Internal Revenue Service to pinpoint and resolve potential tax risks prior to filing.
The OECD has published a range of guidelines for such programs, and a growing number of nations and large corporate taxpayers are working with the process.
“This is where we move away from an adversarial posture based on a lack of trust to one where the taxpayer puts their cards on the table: these are the issues; here is where we have uncertainty; let’s have a conversation,” says Pross.
Greater openness coupled with early certainty “will lead to fewer disputes and should benefit both tax administrations and taxpayers.”
Time to embrace APAs
Perhaps the most effective means is to submit proposed transfer pricing methodologies to authorities within an application for an advance pricing agreement (APA).
“Though these can take a great deal of up-front effort to negotiate, once concluded, they become easier to update/renew and they provide the taxpayer with transfer pricing certainty for the life of the APA,” Canale says.
A more open and transparent approach to MAP cases and APAs would bring further certainty to the international taxation system, according to Picciotto of Lancaster University.
For example, APAs could be used across entire industries instead of for a single company, Picciotto says.
As an example, he cites the Dominican Republic, which created APAs for the package holiday sector.
“Countries should do more to open up their APA and MAP processes so that other taxpayers can see the sorts of agreements being reached and be in a better position to understand how their operations will likely be viewed,” says Picciotto.
Key action points
- As tax transitions to an era of transparency, the number and severity of issues and disputes will increase. Update all transfer pricing to confirm global consistency and full BEPS alignment.
- As tax authorities seek a new, BEPS-driven equilibrium, audits will be increasingly aggressive and frequent. The best way to satisfy auditors is to provide comprehensive, well-documented, BEPS-compliant justifications for transfer prices.
- In cases where the risks of adjustments, interest and even penalties are considerable, companies should consider greater up-front transparency with tax authorities.