Strategic Dispute Resolution in a Post-BEPS World

Transcription

1 Tax Management International Journal TM Reproduced with permission from Tax Management International Journal, 46 TM International Journal 317, 6/9/17. Copyright 2017 by The Bureau of National Affairs, Inc. ( ) Strategic Dispute Resolution in a Post-BEPS World By Barbara Mantegani and Clark Chandler 1 1 Barbara Mantegani is a principal at Mantegani Tax PLLC in Arlington, Va., Clark Chandler is a partner at Economics Partners in Washington, D.C. 2 Mutual Agreement Procedure Statistics for 2015, OVERVIEW The OECD/G20 BEPS initiative has been accompanied by increased audit activity around the globe, with tax authorities focusing on intercompany structures and transactions which, while often passing muster in the past, are now suspect. The EU State Aid decisions raise their own interesting questions, in that having a transaction blessed by a local tax authority no longer appears to offer complete protection from further inquiry and adjustment. Looking at the most recent statistics published by the Organization for Economic Cooperation and Development, 2 virtually every country in the OECD and its partner economies has seen a sharp increase in mutual agreement procedure (MAP) inventories, with an overall increase of 163% between 2006 and Some countries, such as Belgium and Italy, have seen increases of more than 500%, and the United States, despite an increase in resources applied to the MAP office during that period, saw its inventory rise 132%. While these published statistics do not indicate how many of these disputes are related specifically to transfer pricing issues, statistics from the U.S. MAP office show that approximately 75% of the MAP cases filed since 2011 (the first year that the Internal Revenue Service tracked transfer pricing and non-transfer pricing MAP cases separately) are transfer-pricing related. Also, the annual percentage of resolved cases that involve transfer pricing has increased from 57% in 2011 to 90% in Assuming the U.S. s experience reflects the experiences of other countries, it is reasonable to assume that a growing number of transfer pricing disputes are being taken through the MAP process. Regarding Advance Pricing Agreements, the number of countries that have established APA programs has increased from just a handful in the early 1990s to virtually all the OECD countries that report their MAP statistics in 2016, as countries attempt to achieve tax certainty while dealing frequently with reduced resources. The latest major country to establish an APA program, India, represented approximately a third of the new bilateral APA applications filed with the IRS in 2016, suggesting that the relationship between the countries has improved to the point that a prospective remedy could be available and alleviate the double tax case backlog. Finally, anecdotal evidence suggests a similar increase in the number of transfer pricing disputes that are being addressed through a varying array of domestic remedies, including administrative appeals and litigation. Transfer pricing litigation, once rare and limited largely to the United States, is on the rise in a growing number of countries. AND WHAT ABOUT BEPS? A lot has been written about the likely impact of the OECD s Base Erosion and Profit Shifting report on the rules governing transfer pricing. But some highlevel observations are appropriate. First and foremost: The OECD s BEPS guidance can, for the most part, be read as telling local tax authorities that their concerns over the business arrangements and transfer pricing practices of multinational enterprises are valid, and that they have every reason to go forth and 2017 Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. 1

2 implement policies that react to these concerns. However, these tax authority concerns are generally that the local tax base is being eroded; less attention has been paid to the fact that in many cases transfer pricing is a zero-sum game what one country wins, another country loses. And if the loser is not willing to accommodate the winner, the MNE in question pays double tax. Second, while the OECD has acknowledged that tax competition is appropriate if it is used to bring new jobs and other opportunities to a country, it has said that unfair tax practices, and in particular, ones that allow MNEs to take advantage of differences in local rules, are not appropriate. But the OECD has been unable to provide a clear definition of this difference, and as a result both MNEs and tax authorities are left with no clear guidance on how to react. But a failure to react appropriately is likely to undermine any attempt to gain current certainty and to therefore lead to an increased risk of future disputes. Finally, while it is easy to understand why transparency is a desirable goal tax authorities should be able to make their decisions based on a complete and accurate understanding of MNE business arrangements and transfer pricing policies transparency presents practical issues absent a broad-based consensus on rules. One such concern is the Lake Wobegon effect every local legal entity must be above average and must be treated at least as well as any other legal entity. Tax authorities are likely to make such comparisons, for example, using the financial data contained in the Country-by-Country Report (CbCR). However, this information is imperfect the lack of consolidation, as a simple example, can seriously distort results and legal entity financial results are likely to vary widely from each other for reasons that have little or nothing to do with tax planning or transfer pricing. Similarly, the Master File should in theory provide each tax authority with a level playing field, in that each tax authority will have access to the same information as every other tax authority about an MNE s overall operations. However, tax authority reactions to the information presented in the Master File are likely to depend upon local circumstances. Moreover, some of the information presented in the Master File and in particular the list of APAs and other tax rulings will provide insight into the agreements that have been reached with other tax authorities. And while these agreements often depend upon specific local facts, as a practical matter, tax authorities can be expected to benchmark their local performances against such agreements. Once again, of course, there is the question of whether and under what circumstances MAP negotiators will have access to this information. The MAP procedures in most countries require taxpayers to include copies of any settlements, rulings, or agreements that are relevant to the issues in the MAP, but it is possible that MAP teams will want to look at all of an MNE s agreements, or at least more than what is specifically required by local procedures. IMPLICATIONS There is every reason to expect that transfer pricing controversy will continue to increase, and that the management of such controversy will become more complex and less certain as the new BEPS rules are put into place. Some of the more important implications of these changes are discussed below. Centralized tax audit management will become critical. Given the wide dissemination of information between and among tax authorities post-beps, MNE taxpayers are likely to need effective centralized control over audits and other tax controversy. This is particularly true given the move in many countries to conduct joint audits, which requires MNE taxpayers to also coordinate and manage document preparation, meetings, and presentations across countries. Some of the reasons for the centralized management of audits are relatively obvious better management of situations in which two countries are making inconsistent adjustments; the development of a common approach to situations in which multiple countries are making essentially the same type of adjustment; the development of a better awareness of how a MAP settlement in one place might affect the resolution of disputes in other jurisdictions. Other situations may be somewhat less obvious but equally important. For example, tax authorities will now potentially be armed with information that is not immediately available to their local taxpayer and which the parent company might want to want to keep confidential (e.g., tax rulings in another jurisdiction, plans for business restructuring that have not been put in place but which may affect the local entity). However, taxpayers will want to make sure that whoever is dealing with a local transfer pricing controversy is at least as well informed as the local tax authority. Controlling access to information will become more complex. Tax auditors will now start audits with additional information about the international operations of the MNE group. At the very least, this is likely to lead to increased questions about facts that lie outside the control of the legal entity that is being audited. Taxpayers have often tried to limit their responses based on the difficulty in accessing such information and/or their lack of legal access to this information. However, the OECD has clearly taken the position that tax authorities need access to such information, and at the very least tax authorities are likely to expect taxpayers to clarify the information that is pre Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc.

3 sented in the CbC report and Master File, and quite likely will ask for more details on APAs and tax rulings that they believe are relevant. Taxpayers will have to balance the additional costs, time and risk associated with providing this information many of the relevant documents are scattered across the globe; some may contain provisions that prohibit disclosure with the risk that failing to provide as complete and timely a response as is expected will lead to more contentious and adversarial audits. One interesting question is whether proactively seeking to frame the issue that is triggering the inquiry can be used to manage the number of such data requests and ideally lead the audit to a successful closing without adjustment. Acquisitive companies may face special challenges. Acquisitions will come with additional information that will have to be exchanged, not only in terms of business structure, but also in the form of new tax rulings and APAs, past master files and CbC reports, and/or intercompany agreements. This information is almost certain to have inconsistencies, whether large or small, with the information that the taxpayer has provided in the past. Understanding the treaty network relevant to your most significant intercompany transactions, including information exchange, is now necessary in order to manage transfer pricing risk. Another factor that can lead to difficult transfer pricing disputes is the location of the transaction and the treaty network that is in place. Not only is it important to understand where treaties exist (and therefore where an MNE taxpayer can seek the assistance of the competent authorities to resolve instances of double tax arising from transfer pricing adjustments) but it is also important to know what information the treaty partners are exchanging automatically or routinely, e.g., CbC reports or Local Files. It is also useful to the extent possible to have some sense of the relationships between and among treaty partners. For a period between 2013 and 2015, the treaty relationship between the United States and India was extremely problematic, and the countries were not discussing any MAP cases. This fact could have been relevant to taxpayers developing a structure for support services operations, where the disputes were inevitable but resolution would be extremely difficult to obtain. In contrast, and as noted above, the relationship between the countries has appeared to improve in the last two years, which in turn improves the chances of taxpayers seeking resolution of disputes. Understanding the treaty network (and to the extent possible, the treaty relationships) is an important consideration both when setting up a new structure and when making changes to your supply chain. One challenge for U.S. MNEs doing business in Brazil is the lack of a tax treaty between the United States and Brazil, because the lack of bilateral dispute options requires taxpayers to pursue parallel, separate procedures, that are often more expensive and lengthy. While the Treasury Department has negotiated, and the president has signed, several treaties with other countries in South America, until the Senate agrees to take a vote on ratifying them, U.S. taxpayers have few good options for bilateral resolution of tax disputes in that region. In addition, several protocols to existing treaties that would authorize the competent authorities to invoke arbitration, e.g., Japan and Italy, are also awaiting Senate action. Impact on efforts to reach a proactive agreement with tax authorities. MNEs seeking APAs and tax rulings will have to factor the implications of the new BEPS rules on the sharing of such information. First, such rulings, once obtained, will have to be shared with tax authorities generally as part of the master file documentation. 3 Second, and perhaps as important, tax authorities are likely to expect a broader range of information about the MNE s activities as part of the negotiation process, which may have implications for the cost and the time it takes to come to an agreement. One interesting question is whether some of the new MAP options may provide a way of reaching a multi-year agreement without creating a need to share the terms of the agreement. The U.S. revenue procedure issued in 2015 explicitly encourages taxpayers to identify and present potential settlement options to the APMA office, and in our experience, other countries are also open to taxpayer presentations either before the countries begin negotiations or while such negotiations are ongoing. Taxpayers cannot participate in the negotiations themselves, but by helping the countries to frame potential settlement options taxpayers can make a valuable contribution and accelerate the countries time frame to reaching an agreement. Presenting settlement options also signals to the countries that an agreement consistent with the options presented by the taxpayer will be accepted, and the dispute will not move to yet another forum. The competent authorities take seriously their charge to endeavor to reach agreement, and work hard to avoid having a taxpayer reject a settlement that has been agreed between the countries. Another option may be to consider the proactive use of MAP even before an adjustment is final. The U.S. Model Treaty, and the MAP articles of most of 3 There has been a fair amount of discussion about this from the taxpayer perspective the fact that the terms of an APA are shared is probably a good thing for taxpayers if the terms of the APA are consistent with the taxpayer s business arrangements in other countries, but will clearly not be helpful if the reverse is true. One issue that has not received much attention is whether this transparency will also affect the behavior of tax authorities, since the APAs that are shared will tell other countries about the types of deals that the tax authority has entered into Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. 3

4 the U.S. bilateral tax treaties currently in force, allow MAP filings when a resident of a Contracting State considers that the actions of one or both of the Contracting States result or will result for such person in taxation not in accordance with the provisions of this Convention (emphasis added). While taxpayers understandably try to resolve audits before facing an adjustment, and therefore are not thinking about seeking treaty relief while still working with the audit team, in some cases the proactive filing of a MAP case before getting a final audit decision can help reframe the dispute, and allow a disinterested party (i.e., the MAP office) to consider whether the auditor s approach would be defensible in the MAP setting. In our experience this can lead to a closing of the audit without adjustment or, at the least, result in the most problematic issues being removed from the case. Further, to the extent that the transactions at issue are recurring, it might also be efficient for a taxpayer to file an APA application with a rollback request to the audit years, which sometimes results in the audit team stepping back from the case entirely. Depending on local rules, audit teams can stay involved in the APA process, but in our experience, except in the most contentious cases, the audit team frequently cedes authority to the APA team and moves on to examine other taxpayers. Of course, this would require disclosing the agreement to tax authorities generally as part of the Master File Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc.

5 CONCLUSION To summarize, in the post-beps world, MNE taxpayers should expect tax authorities to more closely scrutinize their intercompany transactions and to target any inconsistent treatment of transactions. In light of this, companies are well advised to be consistent with their transfer pricing stories and proactive in their approach to obtaining resolution of the inevitable transfer pricing disputes Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. 5