By Ross Tieman
Pfizer Inc., a multinational pharmaceutical company with operations around the world, has seen an increase in inquiries from tax authorities during the normal audit process in recent years, according to Michael Nelson, Pfizer’s Senior Director, Tax Planning.
Moreover, disputes once resolved during audits are now more likely to be pushed into the upper administrative echelons, or even to court to be settled by judges, he says.
And it’s a global trend. “We’ve seen increased activity globally, including jurisdictions in the regions of North America, Europe-Middle East-Africa, Latin America and Asia-Pacific.”
Taxpayers like Pfizer find themselves in a quickly evolving tax landscape.
“Tax administrations will be more reluctant than in the past to settle before court.“
Jean-Pierre Lieb, EY’s Tax Policy and Controversy Leader for Europe, the Middle East, India and Africa
Governments are increasingly sharing information across borders and are becoming stricter with enforcement.
In addition, new tax laws developed under the base erosion and profit shifting (BEPS) project by the Organisation for Economic Co-operation and Development (OECD) are being rolled out across the world as governments seek to bring tax legislation into the globalization era.
For the next few years, taxpayers are bracing for more uncertainty, disputes and possibly litigation with tax authorities until reforms to the international tax system deliver greater consistency and certainty.
“We are facing an increasingly complex world,” says Nelson. “I think the pendulum has swung in a direction in which there will be more time and resources devoted to tax controversy, more intensity on the part of tax authorities and a greater use of dispute resolution mechanisms.”
‘A tsunami of new disputes’
There’s little doubt that tax controversy is intensifying both across borders and within countries.
According to our annual survey of corporate tax professionals, published in April 2016, enforcement and controversy are the highest tax risks faced by firms, identified by 35% of those surveyed.
Operational risk was pushed into second place.
Tax audits are clearly on the increase.
Last year, another EY survey of 267 senior tax executives from large public and private companies (the majority were headquartered in the US) found that 23% of respondents were under audit, a 10% increase from 2014.
And 72% said the enforcement stance and methods of foreign tax administrations were more aggressive in 2016.
“We’re going to see a tsunami of new disputes in the next two to three years,” one former government official predicted at a recent EY aHead of Tax event.
This reflects more aggressive enforcement of existing rules.
The 2008 financial crisis drove governments around the world to recoup shortfalls in their budgets through increased tax collection.
Tax has become the subject of intense focus and criticism from nongovernmental organizations, the media and politicians.
Increasingly, taxpayers risk being caught in the cross hairs as two countries take different views of what a particular international rule means.
Or they may find past tax positions challenged retroactively by governments.
Resolving doubts through discussions with tax authorities is becoming more difficult: tax administrations appear less willing to interpret the law, so more disputes will likely be settled through the mutual agreement procedure, often a feature of international tax treaties, or even in court.
“Generally speaking, it is more problematic than in the past to get a settlement agreed or to get a ruling from tax authorities,” says Arjo van Eijsden, who heads EY’s tax controversy practice in the Netherlands and Belgium. “Tax authorities are stricter in their interpretations.”
Jean-Pierre Lieb, EY’s Tax Policy and Controversy Leader for Europe, the Middle East, India and Africa, says disputes will also rise because of a greater focus by tax administrations on more technical issues, such as transfer pricing.
“Tax administrations will be more reluctant than in the past to settle before court,” says Lieb.
A surge in disputes could lead to rising costs, potential double taxation or worse.
In some jurisdictions, Lieb says, governments “can use criminal charges against the legal entity, but they will also target those criminal charges against individuals who are in charge of tax structuring.”
The introduction of a global set of harmonized tax rules will also trigger new uncertainties that only rulings can resolve.
The OECD’s BEPS initiative, finalized in 2015, covers everything from transfer pricing, permanent establishments and hybrid mismatch arrangements to treaty benefits and the digital economy.
In theory, the new system should make it easier to calculate corporate tax liabilities and achieve the certainty that companies and governments crave.
But in reality, countries may interpret the rules differently during implementation, leading to heightened controversy over issues, such as the location of intellectual property or transfer pricing, according to van Eijsden.
“There are some very good actions within the BEPS action plan,” says van Eijsden. “But it takes time to adjust legislation at the national and international level.”
Of course, it is difficult for lawmakers to imagine every situation in which tax is payable.
In the past decade or so, for example, digital businesses have gone global with unprecedented speed.
But their business models often do not fit easily into the rules of tax systems designed to impose levies on local, physical assets.
The new economy, with its more varied and flexible working models, contributes to the creation of a “hidden economy” and consequent revenue shortfall for tax authorities, according to a report for the UK’s Office for Tax Simplification.
New laws, including the BEPS project, will address these issues in coming years.
Until then, digital, cross-border businesses will likely continue to be the target of controversy over which taxes they should be paying, at what rate and to whom the tax is payable.
What’s past is prologue
Past tax deals are also becoming a future risk for companies.
The increased data sharing among tax authorities combined with transparency efforts, such as the BEPS’ country-by-country reporting initiative, give tax administrations more information on taxpayers than ever before.
Some are using it to look at past rulings and declarations.
The European Commission, for example, has launched several investigations into tax rulings offered by individual countries within the European Union to select companies or sectors, examining whether State aid rules were breached.
Billions of euros are at stake.
A new and more challenging world of controversy lies ahead.
Key action points
- Give your tax department the adequate staffing, budget and other resources to cope with a rise in controversy and challenges from tax administrations, including more frequent audits
- Review the likely impact of BEPS regulations across your operations and try to identify likely areas of controversy
- Help the board fully understand that tax policy is both a financial and a reputational issue