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Tax Disputes and Controversy Update – Managing disputes in the Post-BEPS World

Managing disputes in the Post-BEPS World

With the G20 Leaders’ endorsement of the Organisation for Economic Co-operation and Development’s (OECD) 13 final reports under its Action Plan on Base Erosion and Profit Shifting in November 2015, it’s now up to individual countries to update their tax treaties and translate the proposals into their domestic law. Some jurisdictions, like the United Kingdom and the European Union, have jumped ahead and already introduced BEPS proposals, while the timing and degree of take-up of the proposals by other countries remains to be seen.


Global Head of Dispute Resolution & Controversy

KPMG in the U.S.


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With the world’s international tax regimes in flux and tax authorities under pressure to increase collections, the potential for tax disputes is rising and expected to swell into an avalanche of controversy in the years to come. Transfer prices are at the core of many OECD BEPS Action Plan items, and so it seems a spike in the number of disputes in this area is inevitable.

To examine the latest BEPS developments related to transfer pricing and how companies can manage their implications, Sharon Katz-Pearlman hosted a recent webcast with Steven Wrappe and François Vincent, Principals with KPMG’s Global Transfer Pricing Services leaders in the United States, Angela Wood, Asia Pacific Leader of KPMG’s Global Tax Dispute Resolution and Controversy Services (GDTRC), and Peter Steeds, Associate Partner and Special Adviser on Transfer Pricing Policy with the GDTRC group of KPMG in the UK.

Economic overview and transfer pricing - Steven Wrappe, Principal, Global Transfer Pricing Services, KPMG in the United States

As a package, the OECD’s 15 Action Plan items aim to modernize international tax regimes and curb BEPS through coordinated rules based on coherence, transparency and substance. While only a third of the Action Plan items address transfer prices directly, many other items overlap, with implications for the taxation of intercompany cross-border transactions as well.

3 levels of transfer pricing documentation

Improved transparency is central to the re-examination of transfer pricing documentation under Action 13. The OECD’s related proposals are designed to give tax authorities the information they need to perform proper risk assessments and conduct audits while encouraging companies to take a comprehensive approach to the global transfer pricing policies. To these ends, the OECD’s proposals under Action 13 would require companies to prepare three levels of detailed transfer pricing documentation:

1. Master file, which provides an overview of the company’s global operations and its various functions

2. Local file, which is similar to current OECD-endorsed contemporaneous documentation and sets out the considerations and rationale for transfer prices set by group companies within a particular country

3. Country-by-country (CbyC) report, which provides a global view of the company’s activities and profits in each country in which the company operates

Data in CbyC reports could increase controversy

CbyC reporting is expected to fuel potential disputes, as tax authorities gain a much broader view of companies’ global tax positions so they can ensure equivalent parts of the organization (e.g., procurement) are attributed equivalent profits in each jurisdiction. Tax inspectors will have access to detailed data by country on revenues, tax payments, capital, earnings and – more controversially – number of employees and tangible assets other than cash and cash equivalents. CbyC reports will highlight special function entities that may earn substantial profits without a substantial number of employees. These final two factors could become significant sources of controversy if tax authorities decide to give them added weight when determining where profits should be allocated for tax purposes.

When are the first CbyC reports due?

Multinational companies would be required to file CbyC reports if their consolidated group revenue in the preceding fiscal year was 750 million Euros or more. The first set of reports is required for fiscal years starting on or after 1 January 2016, and they are due within one year of the fiscal year-end. As a result, companies with calendar year-ends only have until the end of 2015 to adjust structures and operations that might draw attention when the CbyC reports are examined.

The ultimate parent company is required to file the report. If the CbyC report is not required by parent’s country of residence, the company can appoint a surrogate parent entity. Six months after the first filing deadline – or mid-2018 for the first set of calendar-year filers – tax authorities will automatically share the reports with other tax authorities. (In later years, this sharing will occur within 3 months of the filing deadline, i.e., 15 months after the company’s year-end.) Given this timeframe, we can expect to see audit activity arising from CbyC reports commencing in the last half of 2018.

Managing the implications

Companies can prepare to manage the implications of CbyC reporting by conducting a readiness check and risk assessment for each of the three levels of disclosure and by determining your company’s documentation strategy and approach for CbyC reporting. Next steps will involve designing and implementing processes to produce the required documentation.

Transfer Pricing – François Vincent, Principal, Global Transfer Pricing Services, KPMG in the United States

In addition to addressing transfer pricing documentation under Action 13, Actions 8, 9 and 10 of the OECD’s BEPS plan deal explicitly with transfer pricing. These items aim to ensure transfer pricing outcomes align with value creation as it relates to transactions involving intangibles, the contractual allocation of risks, and other high-risk transactions such as management fees. As noted, other Action Plan items also have an impact on transfer pricing. These include:

  • Action 5 on countering harmful tax practices taking into account transparency and substance through, among other things, disclosure of unilateral tax rulings
  • Action 7 on the attribution of profits to permanent establishments using the arm’s length principle
  • Action 14 on improving bilateral dispute resolution mechanisms, which will be hugely important, given that transfer prices are at issue in a substantial majority of double tax disputes
  • Action 15 on development of a multilateral instrument to implement tax treaty measures to tackle BEPS.

Focus on conduct and risk

On Actions 8, 9 and 10, the OECD has proposed substantive changes to its existing transfer pricing guidelines. One area of change involves the delineation of actual transactions. Analysis of functions, risks and assets as set out in written contracts remain the starting point for this exercise, but now the OECD says actual conduct should be weighed to support or contradict the contract. Additionally, the OECD now specifies that synergistic benefits should be allocated on a pro-rata basis. Cash-box entities area entitled to no more than a risk-free return if the only function they provide is financing.

The analysis of risk is given more importance under the new guidelines. The contractual allocation of risk will be more in focus. Weight will be given to the entity’s ability to take on risk, its ability to make and act on decisions in response to risk, and its ability to take steps to mitigate risk. 

Other substantive changes to the OECD’s transfer pricing guidelines are made in these areas:

  • “Recognition” of accurately delineated transactions – The revised guidelines will make it easier for tax authorities to recharacterize transactions than before, except in the rare case that all economically relevant characteristics are the same as those of the tested transaction. The new guidelines maintain the criteria of enterprises behaving in a commercially rational manner, thereby preventing determination of a price.
  • Group synergies – The new guidelines call for consideration of group synergies and the need for deliberate, concerted group actions to produce a clear and material structural advantage.
  • Definition of ‘intangible’ – Legal or contractual protection is not needed for characterization of an asset as intangible; the capability of owning or controlling the asset can be considered.
  • DEPME functions – Functions identified as important for determining returns on intangibles include development, enhancement, protection, maintenance and exploitation (DEPME).
  • Know-how and trade secrets – The OECD has succeeded in getting tax authorities to agree that know-how and trade secrets can be recognized as intangibles.
  • Business valuation – Valuations of goodwill have a role in determining transfer prices, but only as one of many factors to consider in support of the five OECD-endorsed transfer pricing methods.
  • Rules of thumb – Rules of thumb cannot be used as evidence to support an arm’s length price or apportionment (although, in practice, such rules play a role in some areas).
  • Price paid during arm’s length acquisition – The guidelines recognize this price as a useful comparable, even where the intangibles are acquired indirectly through an acquisition of shares or where the price paid to the third party for shares or assets exceeds the acquired assets’ book value. 
  • Projections – The OECD sees projections prepared for non-tax business planning as more reliable than projections done for tax or transfer pricing purposes.

Preferred transfer pricing methods

Among the OECD-endorsed transfer pricing methods, use of the comparable uncontrolled price (CUP) and profit split methods likely would be optimal for pricing intangibles. However, the difficulty of identifying the comparables needed to apply CUP will create pressure to move to one of the alternatives. The OECD plans to launch a new discussion draft and consultation on transactional profit split methods in May 2016.

Finally, ‘options realistically available’ (ORA) will play an even bigger role in transfer pricing analyses than before. Under this concept, independent enterprises would consider all ORAs and be presumed to choose to enter a particular transaction if no other option is more attractive. Because ORAs are treated separately from recharacterization, this change will make it more difficult to resolve a number of transfer pricing issues.

Areas of expected conflict

Some areas where the BEPS changes are expected to open more occasion for dispute involve:

  • Seconded employees and the transfer of know-how
  • Risk management and financial capacity to assume risk
  • Tax administrations’ rejection of especially low prices, such as pricing at marginal cost for underemployed production capacities
  • The treatment of payments blocked as a result of government policies as conditions of the market
  • The identification of intangibles used or transferred with specificity
  • ORAs and non-recognition of the actual transaction
  • Hard-to-value intangibles and tax administrations’ ability to deem price adjustment clauses to exist between the parties (rather than non-recognition of the transaction)
  • The treatment of outcomes based on actual results (rather than projections) as presumptive evidence of pricing arrangements based on forecasts.

Ways for avoiding and mitigating disputes in these areas are set out in the following sections.

Tax Disputes Part 1 – Angela Wood, Asia Pacific Leader, Global Tax Dispute Resolution and Controversy Services, KPMG in Australia

The sweeping international tax changes proposed by the OECD are occurring in an environment that is already rife with tax dispute potential. Since 2008, governments and their tax authorities have been acting under rising media and public pressure to ensure corporations pay an appropriate amount of tax in all their jurisdictions of operation. Politicians are conducting public inquiries into the tax affairs on global companies. Some governments have moved rapidly to adopt BEPS proposals in advance of – and out of synch with – the OECD’s final proposals. Revenue authorities are increasing their cooperation, and cross-border information-sharing will expand even more as CbyC reporting and automatic tax information exchange take hold.

Action 14 calls for better ways to resolve cross-border disputes

The OECD’s Action Plan acknowledges the need for effective ways to resolve international tax disputes as part of the BEPS package. The goal of Action 14 is to improve the effectiveness of mutual agreement procedures (MAP) in the timely resolution of treaty-based disputes between countries.

The OECD proposes to achieve this goal by setting minimum standards for MAP processes and procedures, by making it easier for taxpayers to enter MAP, and by ensuring adequacy of resources and clear, consistent approaches through periodic peer reviews by members of the OECD’s Forum of Tax Administrations (FTA). The FTA will facilitate and lead tax administrations in a collective approach to bilateral dispute resolution that highlights transparency, acting in good faith, and information sharing. 

A number of best practices are endorsed, including advance pricing agreement programs and suspension of the collection of disputed taxes. Procedures for publishing MAP agreements could give taxpayers valuable guidance on how they can avoid potential disputes in the future, although the requirement to publish these results will vary by country.

Taxpayers also stand to benefit from a change that will see both countries involved in a dispute from the initial application stage, rather than just the taxpayer’s country of residence. This will ensure both countries’ viewpoints are considered when weighing a MAP application’s merits. 

Breaking stalemates through arbitration

The OECD BEPS proposals call for mandatory binding arbitration in cases where MAP disputes come to a stalemate. Binding arbitration can bring quicker resolutions, but many countries are unwilling to give up sovereignty over taxing matters by putting ultimate authority for breaking MAP disputes in an arbiter’s hands. Further, it could be difficult to identify arbiters who are perceived as having sufficient expertise and independence –qualities that are critical for an arbitration’s success. Taxpayers may be excluded from the arbitration process entirely, eliminating their ability to influence outcomes.

While the OECD plan acknowledges and aims to mitigate disputes, inconsistent adoption and subjective interpretation could thwart the objectives of the Action 14 recommendations. It also remains to be seen how the MAP changes will interact with domestic dispute resolution processes and whether taxpayers may be subject to parallel but inconsistent regimes.

Documentation is critical

The high potential for tax disputes makes it critical to have documentation on hand that appropriately and comprehensively documents the substance of transactions in terms of what the parties involved agreed and how the agreement is implemented in practice. Facts and evidence to support your position can include not only legal and corporate documents but also documentation of price negotiations, channel profits, staff recollections, correspondence and advice. This evidence should be contemporaneous, and it should be objectively assessed to determine what inferences could be drawn and whether it needs to be supplemented with expert opinion. Finally, the evidence should be evaluated against any domestic transfer pricing laws that may be relevant.

Top 5 ways of avoiding disputes

In summary, the top 5 ways of avoiding transfer pricing disputes and influencing the outcomes of any disputes that arise are:

1. Objectively assess dealings at time they are entered into and evaluate any perceived tax risks that may arise

2. Track information available in each jurisdiction – know what might be shared between revenue authorities

3. Assess relationships with revenue authorities – proactively engage and identify points of influence

4. Review internal resourcing with an eye to ensure adequate resources to manage global tax controversy in-house

5. Adopt technological solutions to track and monitor tax disputes globally.

Peter Steeds, Associate Partner and Special Adviser on Transfer Pricing Policy with the GDTRC group of KPMG in the UK

As the former Head of Transfer Pricing for HM Revenue & Customs (HMRC), Peter Steeds has been deeply involved in the OECD’s BEPS work since the project began. Among other things, Peter served as the UK’s delegate on Working Party 6 of the OECD’s Committee on Fiscal Affairs, and, as the UK competent authority, he was one of the first members of the FTA MAP forum.

Peter says that, for the OECD, developing a coordinated set of international tax rules to address BEPS is only part of the task. Given the extensive changes being made to the world’s tax regimes and high potential for cross-border disputes, businesses were promised first-class dispute resolution mechanisms so they were not saddled with heightened controversy or double taxation, which could hamper business and impede economic growth.

FTA takes charge of implementation

Now the deliverable on dispute resolution under Action 14 is complete, Working Party 6 has handed the task of overseeing its implementation to the FTA. The FTA brings together the tax officials responsible for administering MAP programs. The FTA’s Strategic Plan,  released in 2014, sets out its multilateral strategy for continuous MAP improvement. This group has been charged with delivering globally coordinated MAP processes by the end of 2016.

For the enhanced MAP processes to succeed, the FTA’s peer review program will be the key to ensuring countries live up to their obligations. Currently, a number of countries are failing to commit sufficient resources and falling short of meeting these obligations. Countries also need to move quickly to change their domestic rules and practices to enable universal access to MAP. Businesses can play an important role by keeping pressure on their governments to devote resources and act quickly to effect change.

Changing tax authorities mindsets

Tax authorities’ mindsets will also have to change in order to foster a more collaborative approach to resolving disputes through MAP. While this will take time, there are already signs of improving relationships among tax authorities. For example, since India’s new government was elected in 2014, its tax authority has displayed a more cooperative spirit, introducing measures such as interquartile ranges and APA rollbacks that ease the potential for cross-border tax disputes. As a result, relationships between India’s tax authority and their counterparts in the US and European countries have noticeably improved.

Tax disputes in focus in EU and UK

Meanwhile, developments affecting tax dispute resolution are moving quickly in Europe and the UK:

  • Starting in 2017, the European Union’s Transparency Directive will compel member states to exchange information on all rulings, including APAs, back to 2010. This increased transparency will affect not only EU resident companies but all companies worldwide that do business within the EU, 
  • The interaction of UK’s Diverted Profits Tax (DPT) with APAs is unclear, and there has been some doubt over whether taxpayers can achieve certainty on both DPT and corporation tax in respect of their covered transactions. However, HMRC is eager to ensure the DTP does not derail the UK’s APA program, and it is now becoming clear that such certainty can be gained in appropriate circumstances.
  • HMRC has moved away from unilateral APAs and has instead opened bilateral programs with Switzerland, Italy and others.

Strategic approach to transfer pricing compliance

High-profile developments like these are causing European companies to move quickly to develop a strategic approach to their transfer pricing compliance management. In the US, however, companies have been insulated from these developments and are more concerned about readying their systems and processes for the extensive new transfer pricing disclosures.

With the first set of new transfer pricing reports covering 2016 fiscal years, you won’t want to wait to take action in this regard. Preparing a company-wide standardized response to anticipated inquiries is highly recommended. This response can help demonstrate preparedness to support and debate any issue that tax authorities are likely to look into.

Companies can also benefit from developing a benchmark APA for systemic issues. This involves preparing a bilateral APA between two ‘leading countries’ to address transactions representative of other transactions within the related group. The taxpayer then attempts to use information developed and outcome reached to discourage unreasonable positions taken by other countries on similar transactions. 

For example, taxpayer could negotiate a bilateral US-Japan APA on distribution return. Despite geographic differences, that APA may have relevance with regard to related party distributor returns in other countries regarding sales of the same product.

At minimum, steps to consider taking now include:

  • Identifying potential areas of transfer pricing risk based on information that will be disclosed in country-by-country reports
  • Evaluating the risk of ‘hot spots’ in particular jurisdictions or in respect of particular transactions, taking account of the extent to which documentation supports the alignment of profits with value creation and the procedural options available to engage with local tax administrations 
  • Develop a strategic plan which prioritizes the risks you should address first as well as addressing the global position over time. 

Future Outlook – Where might we be in two years?

Two years from now, most local legislation will have been amended, and taxpayers will be in the midst of dealing with many new rules and requirements.  As a result, we anticipate a dramatic increase in the number of tax disputes in which double tax is in issue, and the Mutual Agreement Process will likely be overburdened by the weight of double tax cases in jurisdictions where mandatory MAP arbitration is not in place.

Some or all of the services described herein may not be permissible for KPMG audit clients and their affiliates.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation.

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