Around the world, taxpayers continue to face tax disputes on a variety of issues. The rise of new revenue authority initiatives continues to make it more challenging for global organizations to protect against, prepare for, and resolve disputes with tax authorities.
What do tax executives need to know to navigate current challenges? A recent webcast led by Sharon Katz-Pearlman zeroed in on recent tax developments in Canada, the United Kingdom and the United States, with commentary and insights from the Global Tax Dispute Resolution and Controversy Services’ (GTDR&C) leaders from KPMG member firms in these important jurisdictions. Their discussion is summarized below.
You can find details about more GTDR&D webcasts in this series here.
Until recently, matters of taxation and tax policy were considered the purview of academics and economists. Debates regarding principles of a good tax system focused on such concepts as efficiency, simplicity, equity and neutrality.
But today, government agendas have become much more concerned with concepts of fairness and integrity including in Canada.
In applying this approach to the tax system, combatting aggressive tax planning by individuals and corporations is positioned as important in the name of fairness and integrity. The Canada Revenue Agency (CRA) has been allocated significantly more resources to help it administer and enforce tax laws.
The CRA is using this to fund a campaign branded as “Cracking Down on international Tax Evasion and Avoidance”, challenging many tax matters that can be labelled as unfair or offensive. Specific actions being pursued under this campaign are as follows:
International electronic fund transfers
Since 2015, financial institutions have been required to report cross-border electronic fund transfers to and from Canada over 10,000 Canadian dollars (CAD). The aim is to help the CRA identify taxpayers who may be avoiding tax or concealing income and assets offshore. Specific offshore locations are under CRA scrutiny.
Collaborating and information sharing
Canada is working with its international peers at the Organisation for Economic Co-Operation and Development (OECD) and the OECD’s Forum on Tax Administration (FTA), primarily to increase transparency around global tax issues.
As a member of the Joint International Taskforce on Shared Intelligence and Collaboration (JITSIC) network, Canada is working with over 35 other countries to coordinate strategies that will ensure that individuals and multinationals are not hiding money and assets offshore. At a JITSIC meeting in January 2017, representatives of Canada took part in the largest ever simultaneous exchange of information to share findings arising from the Panama Papers leak.
Canada is also leveraging the exchange of information provisions of its tax agreements to identify international non-compliance and abuses. Canada has one of the world’s largest treaty networks, with 93 tax treaties and 22 tax information exchange agreements.
Offshore Compliance Advisory Committee
The Offshore Compliance Advisory Committee (OCAC) was formed in 2016 to advise the Minister of National Revenue and the CRA on strategies to combat offshore tax evasion and aggressive tax avoidance. The independent expert committee’s first report, delivered in December 2016, recommends ways to change the CRA’s voluntary disclosure program (VDP).
Offshore Tax Informant Program
Through this program, the CRA provides financial rewards to whistle-blowers who provide specific and credible information about international tax non-compliance. Where the information leads to assessments of CAD100,000 or more in additional tax, the informant may be entitled to 15 percent of the additional tax raised (excluding interest and penalties).
Other actions in Canada to detect tax evasion and aggressive tax avoidance include:
International companies in Canada can expect to experience the impact of this crackdown through these recent shifts in the CRA’s enforcement processes.
Large business risk assessment: The CRA is moving its tax risk assessments for large taxpayers toward a more data-driven approach to evaluating risk indicators and driving audit selection.
‘Crackdown’ versus ‘cooperative compliance’: The adversarial nature of the CRA’s crackdown is out of step with many other jurisdictions, which have moved toward ‘cooperative compliance’ approaches that foster real-time collaboration and trust between taxpayers and tax authorities.
Data analysis and business intelligence: The CRA is employing more sophisticated data analytic and business intelligence techniques to its direct risk assessment and verification processes.
Demands for taxpayer information: Beyond new tax transparency filing requirements, the CRA continues to request large volumes of taxpayer information, such that audit work is being effectively downloaded on taxpayers.
Voluntary disclosures: The OCAC’s recommendations is expected to prompt the CRA to tighten its VDP and possibly weaken the program’s advantages. Taxpayers who may be offside with their taxes should consider applying for the program without delay.
Audit agreements: Given the current uncertainty and delays in resolving tax disputes, taxpayers should consider entering into ‘audit agreements’ at the conclusion of their audits where possible. These agreements outline the issues and clearly define the final adjustments, effectively binding the taxpayer and the CRA for the items at issue. Taxpayers have to waive any objection and appeal rights, but they will obtain certainty in exchange.
Underfunded notice of objection process: The CRA’s increased funding for tax audits have resulted in an increase in tax disputes, but no extra funds appear to have been directed to increase the CRA’s resources for managing its rising tax dispute workload – lengthening the time it takes for the CRA to process objections. Further, a new protocol requires the referral of files back to the audit function where substantial new information is provided at the notice of objection stage.
Don’t underestimate the importance of initial compliance: With the CRA’s increasing scrutiny of data analytics and risk assessment, the accuracy of tax compliance data is crucial. The information reported on tax returns is driving audit selection. If the detailed information is accurate but not sufficiently detailed, for example, for financial reporting on General Index of Financial Information schedules, your return may raise risk flags for the CRA.
Some of the top technical issues that are currently (RC) drawing the CRA’s attention are set out in the table below.
|Top technical issues under CRA scrutiny|
|Non-resident withholding taxes||
Tax Disputes Benchmarking – how does Canada compare?
KPMG International’s 2016 Global Tax Benchmarking Survey offers a snapshot of the structure, governance, priorities and performance measures of tax departments today. A supplementary Global Tax Disputes Benchmarking Survey report zeroes in on the issues faced by those in charge of managing their company’s tax disputes. Some key findings related to tax dispute resolution functions in Canada versus globally are as follows:
According to the respondents, Canadian tax authorities are lagging in their use of new techniques to promote compliance and resolve disputes, such as cooperative compliance, compared to tax authorities globally.
For the complete Canadian supplement to the Global Tax Disputes Benchmarking Survey 2016 visit here.
While there is much overlap in the tax issues and risks faced by large business taxpayers in Canada and the US, developments are unfolding much differently on the American side of the border. Tax reform continues to be a high priority, although the nature of reforms and their timing are uncertain.
In June 2016, Republican House Speaker Paul Ryan put forward a proposal to radically redesign the Internal Revenue Service (IRS) as part of a “Better Way” package of initiatives. It is unknown whether the proposal will proceed.
In the interim, the IRS is navigating more immediate, pragmatic issues resulting from about 1 billion US dollars (USD) in budget cuts in the past several years, with more expected in 2018. Shrinking budget allocations have already led to significant reductions in IRS staff and resources, and future cuts are likely to further affect IRS services. Frustration for taxpayers will likely increase as a result.
In order to manage cumulative budget reductions, each IRS operating division was asked to define its future state in terms of its funding profile. In response, the IRS’ Large Business and International (LB&I) division is shifting its approach from a historical reliance on comprehensive examinations of selected large enterprises and toward centrally worked identification of specific compliance risk issues. 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 focused audits, soft letter-writing campaigns, new guidance and forms or other means.
To support its new issues-based approach, the LB&I has been reorganized to allow for better deployment and more systematic use of geographic and subject matter expertise.
Recent legislation also changes the IRS approach to auditing large partnerships, which represent some 65 – 70 percent of large US taxpayers. This legislation introduces new tools for auditing pass-through entities that give the IRS more visibility into these organizations. More aggressive audits of large partnership will probably result.
The focus on campaigns is still a work-in-progress. The first 13 campaigns announced in February 2017 represent a wide range of sensitivity in terms of risk. Some campaigns deal with mundane, housekeeping matters, while others target known areas of significant risk, such as campaigns focusing on declined or withdrawn offshore voluntary disclosure applications and plans involving medical assistance for children with disability (i.e. Tax and Equity Fiscal Responsibility Act (TEFRA) linkage plans). Other campaigns, like those for micro-captive insurance companies and basket transactions, should put taxpayers on notice that the IRS has determined these arrangements to be potentially abusive and will challenge them aggressively.
The current list of IRS campaigns includes:
This campaign-based approach appears to pose technical and cultural challenges for the IRS, and the traditional approach to large case files will likely continue in some form. However, the Compliance Assurance Process, which promotes a collaborative approach to audits, could be discontinued or scaled back.
Further, as audits become more issues-based, many taxpayers that are not accustomed to audit activity are likely to undergo more intensive scrutiny. Questions also remain over matters such as the extent of taxpayers’ access to IRS subject matter experts, the potential for taxpayers to undergo multiple campaigns at the same time and the impact on traditional dispute resolution mechanisms.
Other IRS initiatives should help provide taxpayers with more certainty. IRS Issue Practice Units and other forms of IRS guidance should offer new levels of transparency for taxpayers, their advisers and IRS auditors alike. The IRS has also committed to hosting a series of webcasts to address taxpayers’ questions and concerns about the new approach and its potential impact on their US tax audit experiences.
KPMG International’s 2016 Global Tax Disputes Benchmarking Survey revealed a number of common themes that tax directors of international companies are dealing with across jurisdictions. These include:
UK-based businesses are no exception, and the UK tax authority HMRC is driving some of these same trends in the UK context.
More frequent contact and information requests
In the past, the amount of contact with HMRC that taxpayers experienced varied considerably, depending on their levels of perceived risk. HMRC designates each business as either low, or non-low risk, based on an assessment of the business’s risk factors. Historically low-risk businesses were rarely contacted by the HMRC, while high-risk businesses were contacted frequently.
However, the approach to low-risk taxpayers became problematic when HMRC reviewed whether those taxpayers should retain their status at the end of three years. Further, the UK’s Public Accounts Committee (PAC) criticized the amount of effort devoted to the HMRC’s initial risk assessment process. As a result, HMRC undertook much more thorough evaluations in the second round of risk assessments, and some taxpayers initially designated as low-risk were subjected to extensive requests for information investigations just to retain their status.
That practice has now gone and all businesses are undergoing ever more regular business risk reviews resulting in more contact from HMRC and requests for information outside of any tax audit process.
HMRC will be consulting UK businesses on how to amend the risk assessment process this summer, which could signal the end of the notion of low-risk status for UK taxpayers altogether.
In the meantime, all businesses are clearly experiencing more contact with HMRC through regular reviews and more information requests outside of the formal audit process.
Another factor behind this trend is HMRC’s new Framework for Cooperative Compliance, announced in February 2017 and now in operation. The framework comprises a set of principles that promote real-time dialogue between taxpayers and HMRC aimed at resolving issues before tax returns are filed. All large businesses are required to agree to work this way and are experiencing more interaction with HMRC.
More audit queries
The rise in audit queries reported by survey respondents globally is not necessarily occurring in the UK. HMRC’s recent successes in reducing the ‘tax gap’ to 6.5 percent – the theoretical percentage of tax revenue owed but not collected – is not merely the result of increased audit activity. Rather, HMRC is getting better at targeting its resources and increasing its compliance yield, for example, by focusing its efforts on transfer pricing, diverted profits arrangements and other areas of higher risk.
More aggressiveness in raising assessments/penalties
While UK businesses may not be receiving significantly more audit queries, they have become much more likely to be challenged on penalties and receive aggressive assessments from HMRC.
Many businesses are being subjected to penalties for failing to respond to HMRC information requests within relatively short timelines. Businesses are typically asked to provide requested information within a month, and, if they do not, HMRC can issue a formal notice. Penalties can apply if the information is still not received. Their severity escalates the longer the information is outstanding, and the grounds for appealing these notices are limited. Once rarely applied, these penalties are now imposed as a matter of routine.
HMRC’s increasing aggressiveness in raising assessments is shown by its tendency to use UK discovery provisions to assess prior years. Until recently, HMRC generally only focused on current-year issues. Now, HMRC is invoking the discovery provisions that allow it to examine and assess previous years when it finds something ‘new’ that leads HMRC to suspect an inaccuracy in those years – a condition that is now being interpreted broadly. ‘New’ can mean something as minor as a new auditor on the file taking a different position than a previous one, or even a change of mind on the part of the original auditor. The courts generally have upheld the HMRC’s view on discovery issues.
On finding something it considers new, HMRC’s practice is to issue an assessment for the earliest possible year. The consequences can be severe, as HMRC can use this power to go beyond the 4-year assessment limit to 6 years in cases of failure to take reasonable care and 20 years for deliberate behavior.
A further factor driving more assessments and penalties is the HMRC’s response to the PAC’s criticism that HMRC was lax in applying behavior-based penalties. HMRC’s practice had been to apply the penalties for carelessness non-compliance in more obvious cases of undeclared income and over-claimed reliefs, and not to situations of legislative interpretative differences.
Where taxpayers are found to be careless, the penalty can be up to a maximum of 30 percent of unpaid taxes, with the possibility of suspension where the business takes steps to prevent the inaccuracy’s recurrence. For inaccuracies deemed as deliberate, penalties can run up to 100 percent of unpaid taxes with no possibility of suspension. Further, where the unpaid tax exceeds the relatively low threshold of 25,000 British pounds (GBP), the taxpayer can be named on HMRC’s public list of deliberate tax defaulters.
Following the PAC’s comments, HMRC has been closely examining taxpayers’ behavior causing inaccuracies and applying these penalties rigorously. HMRC’s also seem to be shifting the boundary between the “careless” and “deliberate” categories of tax filing errors, leading to more challenges that businesses knowingly submitted incorrect tax returns. These trends have occurred during a period when there has been no change in the underlying legislation.
Audits taking longer to conclude/difficulty in reaching settlement
Reflecting the global trend, UK tax audits are becoming more protracted and settlements are getting harder to achieve.
In the UK, changes in HMRC’s structure and governance are contributing to this trend. HMRC’s new Customer Compliance Group concentrates all compliance activity in one group, resulting in more sharing of information and the spread of investigation approaches previously reserved for small and medium enterprises to all business taxpayers.
As of 1 April 2017, HMRC’s three tax dispute resolution boards merged into one, with the Tax Assurance Commissioner as ultimate authority for tax disputes. Settlement proposals in excess of GBP 15 million will be referred to the disputes resolution board with the most significant settlement proposals referred on to HMRC’s three commissioners, including the Tax Assurance Commissioner.
In dealing with tax disputes, HMRC is narrowly applying the principles in its Litigation and Settlement Strategy. Introduced 10 years ago, the strategy requires individual issues to be decided on their own merits, with no package deals or splitting the difference on ‘all or nothing’ issues. HMRC cannot negotiate if it believes it would prevail before a tribunal. Separately, large business taxpayers with complex disputes have little recourse to alternate dispute resolution (ADR) as a mechanism to resolve their dispute as ADR is only being used in a relatively small number of indirect tax issues.
HMRC’s rejection rate for taxpayer settlement proposals shows the impact of HMRC’s governance changes and stricter adherence to the Litigation and Settlement Strategy principles. According to the Tax Assurance Commissioner’s annual reports, the rate of taxpayer settlements rejected nearly doubled from 23 percent in 2013 to 52 percent in 2016.
Percentage of taxpayer settlement proposals rejected by HMRC
Source: UK Tax Assurance Commissioner annual reports 2013 – 2016.
*Dark blue is the percentage of rejections.
If a taxpayer’s settlement offer is rejected, their only recourses are to increase the offer, concede the issue or litigate the matter in the courts.
Achieving positive outcomes
Despite the increasingly challenging UK tax audit environment, there remain practices which can help large businesses resolve tax disputes satisfactorily:
Whatever the jurisdiction, documenting the purpose of your transactions, providing strong support for your positions, and taking a proactive approach to tax audits can help avoid tax controversy or mitigate the impact of tax disputes that may arise.