As global organizations face challenges to protect against, prepare for and resolve disputes with tax authorities, a 5-part webcast series from KPMG’s Global Tax Dispute Resolution and Controversy Services (GTDR&C) visits key jurisdictions across the globe to provide you with what you need to know to stay current.In the first of our series, Sharon Katz-Pearlman led a discussion with tax disputes leaders in Canada, the United States and the United Kingdom. Their discussion is summarized below.
A panel discussion moderated by Sharon Katz-Pearlman, Head of KPMG’s Global Tax Dispute Resolution and Controversy (GTDR&C) ServicesAround the world, taxpayers continue to address a variety of tax disputes issues. Revenue authorities are introducing new compliance programs in efforts to increase collections with fewer resources. Legislative changes arising from the Organization for Economic Co-operation and Development’s (OECD) Action Plan on Base Erosion and Profit Shifting (BEPS), European Union (EU) tax reforms and other anti-avoidance initiatives are transforming the regulatory landscape for tax. All of these changes are occurring at a rapid pace and creating fertile ground for tax disputes.
As global organizations face mounting challenges to protect against, prepare for and resolve disputes with tax authorities, a 5-part webcast series from KPMG’s Global Tax Dispute Resolution and Controversy Services’ (GTDR&C) visits key jurisdictions across the globe to provide you with what you need to know to stay current.
In the first of our series, Sharon Katz-Pearlman led a panel discussion with the GTDR&C leaders from KPMG International’s network of firms in Canada, the United States and the United Kingdom highlighting what tax executives need to know to navigate current challenges in these jurisdictions. Their discussion is summarized below.
Within Canada’s federal government, attitudes continue to harden against tax evasion and aggressive tax avoidance, with the 2015 and 2016 federal budgets closing perceived loopholes in the tax law and devoting significant sums to strengthen the Canada Revenue Agency’s (CRA) enforcement capabilities.
In its 2015 federal budget, the former federal government said that since 2006, it had introduced “over 90 measures to close tax loopholes, clarify tax rules, reduce aggressive international tax avoidance and improve the integrity of the tax system.” ¹In the 2016 federal budget, Canada’s new government, elected in October 2015, committed 444.4 million Canadian dollars (CAD) over 5 years for the CRA to enhance its efforts to crack down on tax evasion and combat tax avoidance. ²Both budgets reiterate the government’s pledge to support the OECD’s BEPS project and act on certain of its recommendations.
Ongoing economic weakness, increasingly urgent infrastructure needs and a will to keep corporate tax rates competitive globally continue to put pressure on the CRA to increase revenue. In addition to pursuing tax evasion and avoidance, the CRA is responding with new approaches to raise revenues by improving compliance across the board.
The shift in approach is evident from the new vocabulary that the government is using to announce anti-avoidance measures. Now announcements on loophole-closing and other anti-avoidance initiatives are framed as measures to enhance compliance and generate more collections from the existing tax base.
The CRA is also working to make more frequent and extensive use of its powers to demand information from taxpayers.
For example, based on a recent court win that is pending appeal, the CRA is going after the analyses of uncertain tax positions that public companies are required to complete to support tax reserves under Canadian generally accepted accounting principles. The analyses in these tax working papers can provide a list of issues for the CRA to consider on audit. Whether the CRA will prevail on appeal remains to be seen. Nevertheless, the CRA’s approach in this regard reflects its stepped-up efforts to gather more data about taxpayers’ affairs.
Among other tools at its disposal, the CRA is active in requesting and sharing information with other tax authorities under tax treaties and information exchange agreements. Tight deadlines for taxpayers to respond to CRA information demands are being strictly enforced. Late taxpayers are suffering arbitrary but binding assessments based on missing or incomplete information. Assessing positions that were rarely invoked in the past are used more frequently, and taxpayers are seeing transactions on the basis that, for example, the arrangement is a sham or amounts were not laid out to earn income. Assessments are being issued that contain multiple positions that are considered binding and valid, even where the CRA’s various positions are in conflict.
In addition to flexing its administrative powers to demand information and raise assessments, the CRA is undertaking a number of initiatives to boost compliance and collections:
• Offshore Tax Informant Program: Through this program, the CRA provides financial rewards to whistle-blowers who provide information about offshore tax compliance. Where the information leads to assessments of CAD100,000 or more in additional tax, the informant is entitled to 15 percent of the additional tax raised. Over 2,000 calls were received under this reporting program in the CRA’s last reporting period ended in 2014.³
• Reporting of electronic funds transfers: Considerable tax audit activity is being driven by the requirement that financial institutions, including casinos, are required to report to the CRA all electronic funds transfers exceeding CAD10,000.
• Expanded foreign reporting rules: Corporations and individuals are required to make detailed and complex disclosures about their assets held offshore. Steep penalties can be levied for failing to provide this information, regardless of whether any Canadian tax is owed on income from these assets.
• Expanding relationships with other governments: In addition to making more use of information-sharing agreements, the CRA is using the collection provisions of Canada’s tax treaties to pursue tax debts offshore.
• Data analytics: The CRA’s Integrated Risk Assessment System links data from the CRA’s various systems and runs it against sophisticated software to benchmark taxpayer activity and update risk assessment models. The system generates an automated risk assessment score for large corporate taxpayers, which can then influence the CRA’s audit coverage of each large file.Areas of focusAreas of particular focus for CRA auditors include:
• ‘BEPS-like’ cross-border financing structures involving hybrid arrangements, cross-border debt and treaty-based structures.
• Transfer pricing, especially as it relates to royalties, management fees, reinsurance, hedging and other financial transactions.
• Business travelers, which is one area where arbitrary assessments are being raised when foreign parties fail to respond to CRA information requests; audits in this area have resulted in multi-million dollar assessments.
• Verification of foreign tax credits, which is now required in the form of proof of foreign taxes paid issued by the other jurisdictions’ tax authorities.
• ‘Treaty-shopping’ arrangements and transactions, although the CRA’s particular focus in this area is unclear.
In this environment, many tax disputes can be preempted by having clear, comprehensive document of your facts and tax positions and by responding to CRA demands for information within their set timeframe. It’s also important to keep adequate, up-to-date books and records in the event that the CRA asks for supporting data for financial statements.
If you are behind on your filings, consider making an application under Canada’s permanent voluntary disclosure program. Although you must meet numerous conditions to qualify, voluntary disclosure can help you get back on side with the CRA while avoiding potential penalties and interest.
Bear in mind that the CRA will risk-assess your tax filings against your peers to pinpoint any anomalies. As a result, one of your best ways to defend against potential tax controversy is to ensure your compliance is of the highest quality and your various filings and submissions to the CRA are made on time.
Within the UK, tax remains high on the agenda with the public, politicians and the media. The HMRC’s recent high-profile victory in achieving a sizable settlement from a global technology company suggests this priority on tax fairness and transparency will continue, especially as new legislation is introduced to strengthen HMRC’s enforcement powers.
New UK proposals in this area include a requirement for large businesses to publish their tax strategies annually, a new framework for cooperative compliance, and some so-called ‘special measures’. Many UK-based companies will also be affected by the European Commission’s recent anti-avoidance tax package.
Under a new proposal, about 2,000 of the UK’s largest businesses (including partnerships and building societies) will need to publish descriptions of:
• their corporate group’s approach to governance in relation to UK taxes• the group’s attitude toward tax planning as it affects UK taxes
• the group’s approach toward dealing with the UK tax authorities
• the level of risk that the group is prepared to accept in relation to UK taxes.
If the rules are passed, the first disclosures for most affected companies would be due by 31 December 2017. HMRC is still consulting on the proposals, and they may change before enactment. Companies that already publish this information voluntarily should ensure their current disclosures fulfill the final requirements, while other companies should be putting in place the documentation to support this disclosure.
As the proposals apply to UK subsidiaries of international corporate groups with group turnover exceeding 750 million euros (EUR), even relatively small UK subsidiaries companies could be caught by the proposals. Companies should review their potential obligations carefully, since non-compliance could attract steep severe penalties.
HMRC’s proposed framework for cooperative compliance is essentially a code of conduct agreement to govern behavior of large businesses in dealings with HMRC. The first draft of the proposals was widely criticized, as they seemed to present a one-sided list of demands for taxpayers only.
Following consultations, the current proposals are more balanced in setting behavioral expectations for both sides. For example, large businesses would be expected to agree to fully and promptly disclose information about material transactions with a tax element in real time, while tax authorities would agree to be prompt and open in their dealings with taxpayers. It currently seems likely that the finally implemented version of these proposals will be voluntary.
The UK government also proposed a series of ‘special measures’ that target persistently uncooperative large businesses. For those companies that fall within this regime, the most significant of these measures bars them from relying on the defense of ‘reasonable care’ in cases of errors in their tax documents. For these companies, any such error could attract a penalty of 30 percent of underpaid tax, regardless of the reason for the error. A further sanction could see businesses being publicly named as subject to special measures.
The EC’s proposed anti-avoidance tax package, introduced in January 2016, would apply to all entities that are located or have operations in the European Union and therefore covers UK-based companies. Some of these measures simply mirror OECD BEPS recommendations in areas such as treaty abuse, permanent establishment definitions and transfer pricing guidelines. However, technical differences in the translation of other measures related to, for example, hybrids, interest deductibility and controlled foreign companies, could contain traps for the unwary.
The package also puts forward some unilateral measures that go well beyond the OECD recommendations, for example, with proposals that would introduce exit charges and require publication of country-by-country tax reports.
These proposals are subject to consultation, and the timing of their potential enactment is unknown. However, as many of these regulations are expected to become law in the foreseeable future, UK companies should prepare to face the challenges of complying with these various anti-BEPS rules.
Within the UK, HMRC has embarked on several projects that aim to improve compliance:
• Diverted profits tax: The HMRC is risk assessing businesses that may have diverted profits and which may be subject to the new diverted profits tax, and it has prioritized tax audit resources to manage these issues.
• Accelerated payment and follower notices: The UK’s move to demand upfront payment for disputed taxes relating to disclosed tax avoidance schemes has changed the economics of tax disputes by creating cash flow implications for companies wishing to pursue disputes. Additionally, after HMRC has won in the courts new regulations allow HMRC to issue ‘follower notices’ requiring payment of tax from other taxpayers with similar arrangements. The new regime has been subject to judicial review, but it is likely that HMRC will succeed to collect the disputed tax in the majority of cases in which accelerated payment and follower notices are issued.
• High-risk corporates program: This program, which taxpayers can enter voluntarily but often is initiated by HMRC through a Board-to Board engagement, allows for highly intensive audit activity to clear all outstanding tax disputes through a dedicated resolution process. With tax disputes on the rise, this program is expected to be used more regularly going forward.
Despite these developments, it remains possible to avoid UK tax disputes in many cases and to reach acceptable settlements when disputes arise. In the current environment, it’s advisable to avoid rushing into compromises with HMRC. Take time to manage your relationships with HMRC, understand their positions and know your options so you can access the optimal dispute resolution alternative. As long as your case is on firm footing, standing your ground can be the key to achieving a better outcome.
After 5-6 years of budget reductions, staff attrition and limited hiring, the US Internal Revenue Service (IRS) is showing signs of strain. The fractious tone of the current US election campaigns makes it seem unlikely that the IRS’ budgetary situation will improve anytime soon. In the meantime, the IRS is taking steps to address its resource limitations. The IRS Commissioner has tasked all divisions to re-design their operations to suit the current budget reality.
Shift in approachTo this end, the IRS’ Large Business and International division is being re-focused to shift away from comprehensive audits of large enterprises and toward centrally worked identification of specific compliance risk issues. The revamped organization is designed around nine ‘practice areas’, with five subject-matter practice areas devoted to broadly defined areas of tax risk covering:
1. Pass-through entities
2. Enterprise activities
3. Cross-border activities
4. Withholding and international individual compliance
5. Treaty and transfer pricing operations The other four practice areas cover geographically designed practice regions.
With three of the five new subject-matter areas devoted to cross-border areas, international taxation will remain a key focus of the reorganized division.
The IRS’ new approach comes with a new vocabulary that includes ‘campaigns’ and ‘treatments’, though the specifics of these new terms remain to be seen. Subject matter experts within the five subject-matter practice areas will be heavily involved in identifying specific tax risks and developing related guidance material and advice. The IRS will then determine which risks warrant issues-based ‘campaigns’ to identify and eliminate specific instances of risks and the ‘treatment’ best suited to the risk’s mitigation – whether through tax audits, softer letter-writing campaigns, or other means.
When tax audits are selected as the appropriate treatment, the audits will be centrally selected, serviced by a mix of local and national resources, and subject to campaign-wide collaboration. Campaign agents will be specially trained to deal with the selected issue and will usually confine their investigations to that issue only.
With this approach, audit teams should be more prepared and coordinated from a technical standpoint. However, taxpayers who find themselves subject to multiple campaigns at the same time may find this new audit approach difficult to navigate.
As anti-BEPS measures are introduced in the US and other countries worldwide, the IRS has concerns about its ability to keep up with the surging audit workload these changes are expected to create for its international tax audit programs. As a result, the IRS is undertaking additional initiatives to improve compliance and enforcement in the international tax area:
• Transfer pricing compliance: The IRS is expected to breathe new life into its advance pricing agreement and mutual agreement procedure programs, which have seen dwindling participation since 2012–13 due to a leadership change.
• Expanded litigation strategy – The IRS has taken the controversial step of involving external tax litigators in tax audits where litigation is a likely outcome. With this move, the IRS appears to be trying to improve its track record in achieving transfer pricing court decisions in its favor. However, the practice raises serious concerns about taxpayer confidentiality and access to information.
• International Practice Units – The IRS has begun publishing International Practice Units (IPU), which instruct IRS agents on the technical treatment of various tax issues. Over 100 IPUs have been issued to date, and the window into the tax authority’s positions can greatly improve certainty over how the IRS will dispense with particular issues in practice.
The reorganization represents a significant shift in the approach to international audits, and it will take some time until the implications for businesses are fully known. Similarly, it could take several years before changes arising from the OECD’s BEPS project and individual jurisdictions’ anti-avoidance measures are implemented and in force. International companies are advised to closely monitor these developments and their potential impact on their tax processes and structures.
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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
¹Department of Finance Canada, 2015 Federal Budget, 21 April
2015, page 349
²Department of Finance Canada, 2016 Federal Budget, 22 March
2016, page 218
³CRA Annual Report to Parliament 2014-2015, page 50