Focus on Top Audit Issues – Selected Countries Part 2

Focus on Top Audit Issue - Selected Countries-2

From the global project to curb base erosion and profit shifting to domestic tax measures to raise sorely needed tax revenue, companies worldwide continue to face ever higher levels of tax audits and disputes. While the future looks bright in the rapidly growing MINT economies of Mexico, Indonesia, Nigeria and Turkey, global companies doing business there face special challenges as tax authorities grapple with the complex tax issues that come with expanding international investment and trade.

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This article presents an overview of the top audit issues being experienced by clients of KPMG International member firms in the MINT (Mexico, Indonesia, Nigeria and Turkey) countries. These countries are confronting many of the same issues set out in Part 1 of this article, which summarized top audit issues in Canada, China, India, the United States and the United Kingdom. However, companies in the MINTs also face distinctly different tax audit challenges, as outlined below.

Mexico – Top Five Audit Issues

Antonio Ramirez, Partner, KPMG in Mexico

 

1

Transfer pricing – maquiladoras

Mexico's maquiladoras are seeing increased taxation and enforcement of tax laws following the cancellation of an incentive tax credit starting in 2014. Transfer prices between maquiladoras and foreign related parties are at increasing risk of adjustment as no specific method or guidance is available on setting such prices. Currently, the only ways maquiladoras can only gain certainty that their transfer pricing will be accepted on audit are by meeting a safe harbor (i.e. 6.9 percent return on net assets) or by entering an advance pricing arrangement (APA). Mexico's tax authority expects to enter into over 1,000 APAs in the current year, primarily with maquiladoras.

2

Transfer pricing – audit approach

Mexico's tax authority has increased its enforcement in the area transfer pricing, conducting risk analyses of taxpayers and, since 2009, working to develop software to help identify transfer pricing audit targets.

Services transactions are a current subject of transfer pricing examinations, with companies increasingly compelled to demonstrate the benefits received from services rendered by related parties. Mexico's tax authority is growing more likely to apply an anti-abuse clause to deny pro rata expenses paid abroad that represent a predetermined allocation of head office fees rather than a payment for a service benefitting the Mexican recipient. This issue is currently the subject of a court challenge. Mexican companies are advised to ensure the benefits of such services are thoroughly documented.

3

Transfer pricing –royalties for marketing expenses

Companies paying foreign royalties for the use of marketing intangibles (e.g. brand names, trademarks) are seeing increasing challenges to the amounts of these payments. Mexico's tax authorities reject arguments that foreign-held marketing intangibles account for a significant portion of a brand's value in the country and are challenging the amount of benefit that Mexican companies receive. The treatment of such payments under Mexican tax law is not clear, and the issue is yet to be tested in the courts.

4

Indirect tax issues

In order to avoid Mexico's mandatory 10-percent employee profit-sharing requirements, some companies have set up services companies to control the amount of affected profits. Tax authorities have responded to such arrangements by looking through the services company and denying value added tax (VAT) input credits. Even though there is no provision in the tax law that allows the tax authorities to take this position, taxpayers are having difficulty objecting to these assessments.

5

Changing tax audit processes and focus

Mexico is beefing up its tax enforcement capabilities by re-designing its tax administration and establishing a new center for large taxpayer audits with a focus on transfer pricing issues. The plan for this new center has been approved, and hiring of specialized audit for pricing audit practices by tracking taxpayer behavior and enhancing auditors' understanding of related-party transactions and international business structures.

Mexico has also established a new administrative dedicated solely to development assessments of tax non-compliance risk for all types of taxpayers.

Source: KPMG in Mexico, 2014 

Indonesia – Top Five Audit Issues

Eko Prajanto, Partner, KPMG in Indonesia

1

Transfer pricing

Transfer pricing has been a top priority of the Indonesian Tax Office (ITO) since 2009, when rules were adopted that oblige taxpayers to disclose additional details of their related-party transactions in their annual tax returns and to declare that transfer pricing documentation is available.

In 2013, the ITO issued detailed transfer pricing guidance for use by auditors and taxpayers. This guidance includes a questionnaire to be completed by taxpayers to test their compliance with the arm's length principle, which requests information such as transaction details and transfer pricing methods employed. The use of the questionnaire is not always effective, as tax auditors may not follow up on its content when conducting their investigations.

2

Changing tax audit focus and new national revenue targets

In 2013 and 2014, ITO auditors have become more aggressive toward transfer pricing and have made significant tax adjustments, including adjustments affecting the deductibility of expenses for related-party transactions. ITO auditors tend to re-determine transfer pricing based on their own research and analysis, even where taxpayers maintain their own transfer pricing study or documentation. Tax auditors are reluctant to reverse their findings on related-party transactions, so taxpayers often need to resolve transfer pricing disputes through appeals to the Tax Court.

Audit procedures for group transactions changed in 2013 to ensure that where a fiscal correction on an inter-company transaction is made for one company, it is also corrected for the other company. Otherwise, double income tax or VAT would result.

National revenue targets for tax audits for 2014 is 24 trillion Indonesian rupiah (IDR; approximately 2.4 billion US dollars) – a significant increase from IDR18.5 trillion for 20131 and IDR13.3 trillion for 2012.2 The ITO also set its audit coverage ratio (ACR) for corporate and individual taxpayers at 5 percent and 0.1 percent respectively for 2014.3 The ACR is calculated based on the number of tax assessments issued by ITO divided by the number of tax returns submitted by taxpayers.

For corporate taxpayers, tax auditors focus on real estate and financial services businesses. For individuals, tax auditors focus on business owners, shareholders and notary/land deed officials. Tax audits can expand from a desk audit to a wider field audit if there are transfer pricing issues or financial engineering transactions.

3

Cross-border transactions

In Indonesia, major audit issues can arise for these cross-border transactions:

  • Income from the provision of services and royalties treated as disguised dividends. Disputes are arising over the treatment of services fees and royalty payments to related parties. At issue is whether the amounts can be treated as fees for active services, payments of royalties or dividends.
  • Lack of Certificate of Domicile (COD) or DGT 1 Form for claiming treaty benefits on the cross-border transactions. In the absence of these documents, the ITO applies withholding tax at the domestic tax rate of 20 percent on cross-border transaction involving, for example, services, royalties, interest and dividends paid to non-resident taxpayers. Taxpayers should submit the DGT 1 Form to the ITO together with their monthly tax returns when transactions are incurred.

4

Indirect tax issues

ITO auditors are closely scrutinizing the validity of the VAT invoices issued and credited by taxpayers. Major issues confronting taxpayers are:

  • late issuance of VAT invoices by taxpayers (as sellers)
  • invalid input VAT invoices credited by taxpayers (as buyers)
  • self-assessed VAT on the use of offshore services and intangible goods, as most Indonesian taxpayers neglect to collect self-assessed VAT at 10 percent on offshore and royalty services fees paid to the non-residents.

5

Legislative uncertainty

Indonesia's rapid development is straining the country's resources and adding pressure on the government to increase tax collections. After facing a series of tax reforms in the past two years, companies in Indonesia are expected to encounter more tax legislative amendments as the government seeks to tighten its tax base with possible new rules to address, for example, transfer pricing, tax transparency and information exchange and thin capitalization.

Source: KPMG in Indonesia, 2014

1 ITO Circular No. SE-11/2013.

2 ITO Circular No. SE-07/2012.

3 ITO Circular No. SE-15/2014.

Nigeria – Top Audit Issues

Victor Onyenkpa, Partner and Head of Tax, Regulatory and People Services, Tax Dispute Resolution & Controversy Services, KPMG in Nigeria

1

Payroll / employment tax issues

Personal income tax audits are growing increasingly difficult to navigate as Nigerian tax inspectors put more focus on how employers are managing their employees' source withholding obligations. Audit scrutiny is particularly acute in the oil industry as service companies are reluctant to disclose details of employees' offshore earnings. As a result, tax inspectors make adjustments based on deemed salary amounts.

2

Changing tax audit processes and focus

As Nigeria's tax authority puts more priority on raising tax revenue, it is adopting increasingly aggressive tax audit techniques. Audits are approached with the expectation that additional amounts will be raised through adjustments. Common tax audit targets include intercompany transactions and cross-border revenue-sharing arrangements. Although it is possible to obtain an advance opinion on how the tax authority would treat a planned transaction, such opinions are not binding and have been known to be reversed after a planned transaction has been executed.

3

Transfer pricing

New transfer pricing documentation regulations were enacted in 2012, and the first set of filings under these rules were due in June 2014. How strictly these rules will be enforced remains to be seen, but taxpayers should ensure their transfer pricing documents are strong enough to withstand close scrutiny. The new regulations provide for the possibility of negotiating advance pricing agreements with the tax authority, which could help companies gain more certainty that their transfer prices will be accepted on audit.

4

Deductibility of expenses

Companies in Nigeria are seeing more of their deductible expenses denied as tax auditors step up their enforcement of documentation requirements. Poor record keeping, especially of invoices, receipts or other documents needed to support the deductibility of their business costs, is common in Nigeria.

5

Inefficient tax appeals process

In the event of tax controversy, taxpayers in Nigeria can take their disputes through various levels, starting with a Tax Appeal Tribunal and ending with the Supreme Court. In practice, few companies succeed in having tax authority decisions reversed by the Tax Appeal Tribunal, and few pursue tax disputes through the courts, due to the considerable length of time involved and the risk of jeopardizing their ongoing relations with the tax authorities.

Source: KPMG in Nigeria, 2014

Turkey – Top Audit Issues

Abdulkadir Kahraman, Partner, Head of Tax – KPMG in Turkey

 

Cross-border structures and transactions

As a member of the Organisation for Economic Co-operation and Development (OECD), Turkey supports the OECD's base erosion and profit shifting (BEPS) project and its government is putting priority on the gathering and exchange of taxpayer information, for example, by expanding its network tax information exchange agreements (TIEA) and tax treaties. The use of cross-border structures by Turkish investors has been restricted under the Turkish Controlled Foreign Corporation (CFC) rules. Turkey is also implementing an anti-avoidance regime to address tax base erosion through transactions with tax havens. The Turkish tax authorities' approach to treaty abuses and substance requirements is expected to become more stringent as a result of BEPS project. Turkish tax authorities currently focus their attention on withholding taxes on payments to non-residents, transfer pricing issues related to foreign group entities and avoidance transactions, using a substance-over-form approach to tax audits in these areas. Recently, tax inspectors have used both domestic and treaty anti-abuse provisions to challenge group structuring activities (e.g. share transfers from one holding jurisdiction to another to access better treaty rates).

2

Transfer pricing

In the area of transfer pricing, the Turkish tax administration is targeting large royalty payments, management fees transactions and loss-making companies. Under particular scrutiny are royalties, management fee payments and cost allocations of local members of global organizations that are portrayed as low-risk companies (e.g. distributors, contract manufacturers) entitled to low operating returns.

Tax inspectors often focus on whether the services to the Turkish taxpayer are supported (e.g. through an intercompany agreement) and provide a benefit to the recipient. The use of indirect cost allocation methods based on budgeted turnover of the service recipient companies is being challenged on the grounds that the allocation is a pre-determined service fee payable even when no actual services are received during the period. Where the services are not well documented to prove their necessity, they are likely to be treated as royalties and subject to withholding tax, or as non-deductible.

Transfer pricing risk also arises in connection with large price adjustments in the form of debit and credit notes. There are few tax rulings to address the issues involved with such adjustments, and the Turkish tax authority does not have a clear approach on how to treat these transactions. Taxpayers face the risk of not being able to deduct additional VAT paid and/or potential customs penalties as a consequence of price adjustments.

Companies in Turkey are also challenged in identifying arm's length prices for intercompany transactions, which is difficult due to the absence of direct market comparables. Coupled with the tax administration's use of secret comparables, Turkish taxpayers are significantly disadvantaged when defending their transfer pricing positions.

Foreign investors and companies should monitor their intercompany dealings with their local Turkish companies closely and take a proactive approach to complying with regulations and defending their intercompany pricing policies. Negotiating an advance pricing arrangement has emerged as one of the most efficient and safest ways to achieve certainty and favorable treatment where transfer prices are concerned.

3

Changing tax audit processes and focus

In 2006, Turkey commenced a program of corporate tax reform and adopted an array of changes to its tax regime in regard to cross-border related-party transactions. For example:

  • Transfer pricing legislation went into effect in 2007, and newly formed teams of tax inspectors dedicated to transfer pricing cases have increased the depth of transfer pricing related audits.
  • A 30 per cent withholding tax on certain payments to residents of tax haven countries was introduced but has not been implemented as the list of tax haven countries has not yet been announced.
  • The controlled foreign corporation regime (CFC) that is now in place that subjects a CFC's profits to taxation in Turkey in certain conditions.

In addition to pursuing TIEAs, Turkey is renewing its existing tax treaties by adding information exchange and administrative cooperation clauses. These efforts to enhance cooperation and exchange of information between Turkey and foreign jurisdictions are expected to help enforcement of a new cash repatriation law was introduced in May 2013 that aims to bring Turkish citizens' assets back to Turkey, following on a similar law introduced in 2009.

Turkey also signed an administrative cooperation agreement with the European Union to enable effective information flow and administrative support for auditing cross-border transactions.

4

Payroll / employment tax issues

Payroll taxes are under greater tax audit scrutiny, especially where payroll calculation corrections are made and taxable income decreases. Employment tax issues related to employees who travel across borders are also in focus as the Turkish tax offices receive more notifications from foreign tax offices about the residency status of foreign employees working in Turkey. In auditing these employees, the tax authorities are requesting documentation that tax withholding and reporting obligations have been met.

5

State and local tax issues

As Turkey derives more than half of its tax revenue from indirect taxes, the application of indirect taxes is becoming more significant – and more complex. Companies should ensure they have a tax-efficient structure for managing their VAT, special consumption tax, customs and stamp duty obligations.

Customs audits are increasing in frequency and scope, with errors commonly detected in determining the correct tax rate, declaring the correct amount and applying appropriate procedures. Companies can benefit from opportunities to reduce their customs duties through improved supply chain management, free trade agreements and the use of appropriate customs and foreign trade tools.

In terms of VAT, common areas of dispute include:

  • rejection of VAT credits on costs and expenses that have challenged from a transfer pricing perspective
  • reverse VAT charges where services in Turkey's free trade zones are obtained from abroad
  • Rejection of VAT refunds and input credits due to periodicity principle.

In order to benefit from input VAT credits, purchase invoices should be booked within the fiscal year when the taxable transaction is made. Conflict with tax authorities can arise where input VAT on invoices is received late and booked in the following fiscal year and where reverse-charged VAT amounts are declared late in the following fiscal years.

Source: KPMG in Turkey, 2014

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