It was not that long ago that a multinational taxpayer could report information differently to one taxing authority than to another even within the same country without significant concern. How often did a value reported for customs and duties purposes match the transfer pricing value for income tax purposes? Probably not very often and what difference did it make? Back then, not very much difference. Now, it makes a huge difference.
What’s Changed in Information Sharing?
The road to where we are today has not been difficult to follow for those that have been actively involved in international tax for the last decade or so. Global tax authorities have been becoming considerably more aggressive for years and that is not a trend that shows any signs at all of abating. Tax authorities have long sought complete transparency in the taxpayer’s supply chain taxation both in the home country and elsewhere. It makes their job much easier and it forces multinational taxpayers to full disclosure of their global tax positions.
There have been many governmental bodies actively pushing these efforts for some time now but the three biggest, at least to U.S. taxpayers, have been the Organization for Economic Cooperation and Development (“OECD”), the EU, and the IRS. Our clients feel this most directly with their Base Erosion and Profit Shifting (“BEPS”) and Foreign Account Tax Compliance Act (“FATCA”) filing requirements.
For U.S. taxpayers, this means a sharing of not only information gleaned from their Form 1120, Forms 5471 and 5472, and customs and duty filings but also what they are reporting on similar non-U.S. filings. When you add government filed transfer pricing filings to all of this you can see how quickly a very significant database of highly confidential and valuable business and financial information can be created and shared.
The Impact of Electronic Filing
Most multinational taxpayers are slowly becoming attuned to the fact that what they are reporting to one country has a significant impact in other countries as well. What many are not sufficiently aware of is that their tax and financial information can now be quickly cross-referenced and shared among numerous governmental taxing authorities with the click of a button.
Electronic filings and sophisticated digital data collection methods allow tax authorities to reach deeper than they ever have before into the taxpayer’s supply chain data. Multinational taxpayers must electronically submit a variety of data that goes beyond tax records in formats specified by different tax authorities often within the same country, e.g., customs, duties, income tax, and VAT. All of these authorities now utilize sophisticated data analytics engines to discover filing discrepancies and compare data across jurisdictions and taxpayers. These governments then issue tax and audit assessments based on these analyses.
It is essential that multinational taxpayers understand the shift from a single country filing view to a global filing view. Tax filings simply have to be viewed as being globally transparent in terms of information sharing, comparative risks, and tax controversy strategy and resolution. Very little if anything is hidden and not shared.
The drivers behind this are numerous. Over 100 countries have signed onto the OECD’s Country-by-Country reporting initiative. The OECD’s Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (“MLI”) desires to update over 3,000 double tax treaties to incorporate BEPS changes. It went into effect in July 2018 with 75 countries on board. The MLI requires a principal purpose test for a multinational taxpayer’s tax positions and creates a simplified limitation of benefits provision to curb treaty abuse. This means that tax treaty benefits will be denied when procuring a tax benefit was a principal purpose of a business arrangement.
The OECD is offering a new tool aimed at taxpayer certainly in this new environment. The OECD created International Compliance Assurance Program (“ICAP”) is a voluntary pilot program where, in return for transparency of their tax risks, taxpayers receive some assurance that they will not be targeted by governments participating in the program. In theory, a successful ICAP result provides multinational taxpayers more certainty and a reduced overall global tax risk profile. It is a program with promise but it is being rolled out as a pilot program only in the face of an ever more aggressive tax environment that is not a pilot program.
Tax Adviser Rules
One very significant change impacting practitioners both in the U.S. and worldwide is the EU’s recent update of the Directive on Administrative Cooperation (“DAC”). Under the new DAC rules, intermediaries such as tax advisers, accountants and lawyers that design, promote or implement tax planning strategies are required to report any potentially aggressive tax arrangements directly to the tax authorities. Very concerning , mainly due to the broad scope of definitions provided in these rules, is that reportable arrangements may include arrangements that do not necessarily have a main benefit of obtaining a tax advantage. These new mandatory disclosure rules will have material implications for both advisers and their clients.
According to the DAC, a “reportable cross-border arrangement” refers to any cross-border tax planning arrangement which bears one or more enumerated features listed in the DAC and concerns at least one EU Member State. The enumerated features are broadly scoped and represent certain typical features of tax planning arrangements which, according to the DAC, indicate possible tax avoidance. Certain transfer pricing arrangements must be reported even if they do not have a primary purpose or benefit of obtaining a tax advantage. This include arrangements that involve hard-to-value intangibles or a cross-border transfer of functions, risks, or physical property.
Creating A Global Tax Risk Strategy
Multinational taxpayers that are relying on traditional global compliance practices and reporting models will ultimately lose control of their own tax narrative. These antiquated – and now dangerous – practices feature single country income tax reporting that is not coordinated with operational tax reporting like excise taxes and customs reporting.
When one takes into account decentralized management teams, non-integrated mergers and acquisitions, and information systems that are not coordinated or unable to provide required information in a timely manner, one can see the true scale of the problem. Tax risk must be managed on a global basis. Local, or even regional, management is simply not sufficient.
As tax reporting becomes even more digitally interconnected, existing problems will only grow creating more economic and legal risks to international business strategies. What we are now experiencing has been long perceived and is the future of tax and financial reporting. There really is no getting around it.
We are often asked by our clients how to best manage this new global environment. We advise that multinational taxpayers strategically address these issues proactively on a global basis. The risk of not doing so is to hand over important financial data to numerous tax authorities without a clear understanding of how they’ll use it or how it will impact the taxpayer’s core business strategies.
There are steps that can be taken to minimize the impact of these new rules. in a consistent and strategic way will be better equipped to manage controversies as they arise. Specific steps businesses can take to adopt a more consistent global approach to tax controversy management include:
- Centrally manage global tax filings to ensure consistency and understanding of what is being disclosed and where. This involves enhanced communication and processes between global reporting teams that may not have existed before. This is, in practice, a cultural shift in how global finance teams address tax matters.
- Modify, update, or create information reporting systems that can timely comply with global reporting rules while still allowing time for appropriate tax leadership review prior to filing. Never has the need for information systems to be responsive to tax needs been higher. These systems must not only produce data but do so in a coordinated and strategic manner.
- Design and implement a global policy relative to tax compliance, reporting, and response to tax authority inquiries. This policy must not only be nimble but it must fully comply with increasingly complex local rules.
- Involve senior management, Board leadership, and even internal audit teams to create a corporate governance plan that complies with SOX requirements but also allows swift communication of tax related risks to strategic business plans and financial reports.
- As an adviser/intermediary or taxpayer, understand when a transaction qualifies as a “reportable cross-border arrangement” under the DAC. Unless a legal professional privilege applies, disclosure is necessary. If multiple advisers are involved, each adviser must comply with the reporting obligation unless a report was filed by another adviser.
Even the most sophisticated taxpayers are having trouble keeping up with these new rules and requirements. It truly represents a cultural shift that has been long coming and shows no signs of abating. Only by maintaining awareness of new global reporting rules and creating strategies and processes to ensure both conformance and strategic awareness can economic risks be minimized and global business strategies preserved.
Frank J. Vari, JD, MTax, CPA is the practice leader of FJV Tax which is a CPA firm specializing in complex international and U.S. tax planning. FJV Tax has offices in Wellesley and Boston. The author can be reached via email at firstname.lastname@example.org or telephone at 617-770-7286/800-685-2324. You can learn more about FJV Tax at fjvtax.com.