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Governments know more than ever about businesses’ tax affairs due to advanced technology and the OECD BEPS frameworks.
In brief
- A new era of increasingly granular tax reporting has been ushered in by the OECD’s Base Erosion and Profit-Shifting (BEPS) frameworks.
- Other disclosure directives such as FATCA and CRS have added to this scrutiny, making transparency a key requirement for compliance.
- Organizations should address reporting challenges in four key areas: transfer pricing, indirect taxation, customer tax operations and tax controversy.
The Organization for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) frameworks have helped spark a dramatic shift in corporate tax transparency since 2013.
Dubbed an “international collaboration to end tax avoidance,” by the OECD, the BEPS project ushered in an unprecedented era of multilateral collaboration on tax policy and administration matters, as well as a new era of tax transparency for cross-border enterprises. It currently involves 139 countries1, many of which are now anxious to recoup revenue to offset the costs of the COVID-19 pandemic.
Businesses’ tax reporting requirements are becoming more granular with BEPS too. Under Action 13, for example, all large multinational enterprises are required to prepare country-by-country (CbC) reports, sharing data on the global allocation of economic activity, income, profit and the taxes they pay. At the time of writing, 90 countries have introduced CbC reporting filing obligations.2
Other recent directives, such as Foreign Account Tax Compliance Act (FATCA), and its EU equivalent, Common Reporting Standard (CRS), only add to the scrutiny – requiring financial institutions to provide information about their customers in certain circumstances, to help authorities understand their income and potential tax obligations.
Eight years since increasing tax transparency was viewed as a conceptual idea, it is now the norm in every facet of tax, from transfer pricing to VAT. Armed with increasingly powerful machine learning and data-sharing tools, tax authorities can now gain increasingly deep and timely access to businesses’ records.
“The impact of these changes has been nothing less than staggering,” says Luis Coronado, EY Global Tax Controversy Leader. “The traditional information asymmetry between taxpayer and tax authority – where the authority always saw the taxpayer as largely opaque – has been turned on its head.”
Such transparency is set to increase even further as tax authorities continue to press for vital revenue. In total, 105 jurisdictions were due to exchange information by the end of 2020 (including, for the first time, Nigeria, Oman and Peru). That figure is set to increase to 115 by 2023.3
Meanwhile, real-time data reporting technologies are spreading to revenue authorities around the world.
Faced with such a fluid environment, tax functions must ensure they’re prepared, in several key areas.
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Chapter 1
Tax controversy is on the rise
More tax transparency can mean more targeted tax controversy. A well-defined, common approach to managing it can help.
Given the increase in transparency development and increasingly powerful enforcement tools, tax controversy appears to be on the rise – and becoming more targeted too.
“Authorities can profile their audits better than in the past, as they now have greater insight into possible errors in a company’s information thanks to transparency policies and technology enablement,” says Coronado.
This increase may cause challenges for many businesses. In the 2021 EY Tax Risk and Controversy survey, 66% of respondents said tax controversy has increased in importance to their company4 in the last three years. Yet only 24% said they have complete visibility of all tax audits, disputes and litigation globally – and the tax controversy landscape is about to become even more complex.
As authorities become more collaborative, empowered and sophisticated, global supply and value chains are becoming increasingly complicated. So, too, are cross-border tax architectures and national-level tax reforms. Meanwhile, new models of multinational business are emerging that weren’t even considered when current tax rules and double tax treaties were first drafted.
All of this suggests organizations can expect more disputes, of an increasingly broad and complex nature, often cropping up in multiple countries concurrently.
In order to prepare, those organizations have to prioritize building the “tax controversy department of the future,” a step-by-step methodology reshaping of the tax function according to a well-defined, commonly agreed approach to managing global tax controversy. (via EY.com UK)
This reimagined function uses new tools and processes to gain control and visibility over taxes, gathering deep insight into the full spectrum of its tax affairs, with a clearly defined approach to managing controversy. It also stays closely connected both to key internal stakeholders – such as the C-suite, board, and various business units – and to tax authorities and policy makers.
And as there’s now less and less time between completing a transaction and facing the scrutiny of the tax authorities, the onus is on being proactive. “If you’re looking at managing controversy only at the end of the tax lifecycle – with the audit or litigation – it’s too late,” says Rob Thomas, a director in EY’s global tax controversy network. “You have to stem the tide of risks that turns into disputes.”
This means optimizing the use of people, processes, data and technology to identify, address and manage potential risks and disputes sooner than ever before.
“It’s about converting controversy to control,” says Marc van der Graaf, Associate Partner, Tax Technology & Transformation, at Tax Belastingadviseurs LLP in the Netherlands. “The tax function needs certainty, which means having confidence in its data and processes.”
Without that? Companies are simply inviting risk, whether in unexpected disputes, double taxation, or increased financial penalties, interest and surcharges. Reputational risks become real, while relationships with revenue authorities may deteriorate. And companies may find themselves exposed to the significant costs of a drawn-out audit process.
There are three major building blocks for the tax controversy department of the future:
- Tax risk assessment, with the aim of stopping controversy before it occurs
- Tax risk management, which helps manage the impact of controversy, via execution of a comprehensive strategy and controls to manage all tax risks
- Tax audit management, which enables quick, effective resolution, allowing the tax function to move forward and focus on value-adding work
“These processes help to make you compliant, and better able to avoid controversy wherever possible,” says Fiona Campbell, EY Global Indirect Tax Quality Leader. “But if you do get involved in controversy, penalties can often be mitigated by showing you had good controls in place and that the error wasn't careless. So that's what we recommend to clients: make sure you have the information and always know what you're dealing with.”
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Chapter 2
A 'game changer' for transfer pricing
More transparency around transfer pricing means more scrutiny and audits in a function already considered a high source of tax controversy.
Transfer pricing is one area of tax where transparency has increased dramatically as a result of BEPS. BEPS Actions 8-10 set out to ensure transfer pricing is better aligned to value creation within multi-national organizations. This includes guidance on the application of the arm’s-length principle and the approach for appropriate pricing of hard-to-value intangibles.
The world’s tax authorities now have information on how a given company divides profits country-by-country, and can compare that to data on dozens of that company’s industry peers. And those authorities will be sharing data with other tax administrations where the company does business.
For this reason, Tracee Fultz, EY Global Transfer Pricing Leader, describes BEPS 2.0 as a “game-changer.”
Given such openness, companies can expect growth in the number and scale of transfer pricing audits, as well as instances of double taxation. They also face increased scrutiny and risk in areas such as permanent establishment and intangibles like intellectual property, as a fast-changing economy sparks new definitions of what constitutes substance.
“The margins on a country-by-country basis will be more visible, and that's bound to give rise to questions as to why margins differ between countries,” says Chris Sanger, EY Global Government and Risk Tax Leader. “Although the differences could be perfectly justified, they may still prompt questions and ultimately controversy. In a trusting co-operative compliance environment, where the tax authority understands your model, they're both less likely to be surprised when those results come out and more able to appreciate why such disparities could arise. This again points to the benefits of getting to that level of trust.”
All of which demands more of transfer pricing teams in terms of skills, processes and, crucially, technology.
Fultz asserts that one of the ways BEPS will change the tax department lies in encouraging the transfer pricing function to automate. Companies should pivot from the common practice of adjusting transfer pricing in hindsight in favor of being proactive, carving a clear understanding of where and how value is created across the business, and why their profit allocation systems are appropriate.
“BEPS doesn't mean the end result of the transfer pricing is any different,” says Fultz. “But how you document that transfer pricing, and the information and data you need to do so, certainly is. Very much so. The tax department needs broad automation and process controls for setting, monitoring and invoicing its transfer pricing. That’s the big challenge. Right now, I’d estimate only 10-20% of companies have automated the whole thing. BEPS will force everyone up that curve.”
One proactive means of gaining clarity around transfer pricing is the Advanced Pricing Agreement (APA), in which two countries come to an arrangement as to a company’s transfer pricing. An APA can give a company certainty in its transfer pricing for as long as five years, while also leaving it clear of risk of transfer pricing adjustments and double taxation.
Yet APAs can be a resource-intensive process, as they require someone in the internal tax department to oversee them. Yet according to the EY 2021 Transfer Pricing and International Tax Survey, 82% of companies anticipate 82% of bilateral APAs will be useful to prevent disputes in the coming three years and 70% said multilateral APAs will be very or somewhat useful during that time.
Another proactive approach is the OECD’s new International Compliance Assurance Programme (ICAP), a voluntary program that uses country-by-country reports to reduce transfer pricing disputes. ICAP doesn’t offer the legal certainty of an APA, serving instead as more of a non-binding, advisory health-check, where governments study a company’s transfer pricing documentation and advise on whether it’s appropriate.
Other tools are reactive. A mutual agreement procedure (MAP), for example, enables two tax authorities to communicate directly if there are concerns a taxpayer may be subjected to double taxation. The MAP process can be complex and burdensome and, like an APA, can easily tie up resources. Yet governments have made a commitment under BEPS Action 14 that MAPs should only take 24 months before moving to arbitration.5 This may make MAP more effective.
Litigation, meanwhile, offers another potential avenue, albeit one that’s often costly and which applies only to that one particular country. If a company wins its case, or makes a settlement along the way, there’s no guarantee it won’t be exposed to taxation elsewhere.
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Chapter 3
Indirect taxes get more transparent
As indirect taxes generate higher proportions of national tax revenues, governments turn to real-time filing to boost compliance.
Tax and customs administrations are also stepping up compliance and enforcement efforts around indirect tax. Indirect taxes generate around 30% of the national tax revenues for OECD member states – as much as personal and corporate income taxes combined.6
Yet there remains a significant tax gap. As a self-regulating tax, indirect tax has always been open to mistakes and fraud, especially as reports tend to require no transactional-level detail.
It should come as no surprise, then, that many authorities should seek to move from a retrospective filing system to something closer to real time, in order to increase indirect tax transparency, reduce evasion and maximize revenue.
“When VAT was introduced into the Gulf states, companies were submitting their returns and then getting questions from the authorities the next day, almost,” says Campbell. “In India, meanwhile, companies report details of specified GST documents to a government portal and obtain a reference number, so they can see in advance. There are big differences in application between countries, but many are heading that way.”
This can be very challenging for organizations, and not just because governments can use these powerful tools to quickly catch a lack of compliance. Indirect tax is a very complex area, requiring interfaces between the company’s data and the authorities’ systems. As there’s currently no coherence in the approaches followed by different jurisdictions, it exacerbates risks and costs.
For these reasons, indirect taxes are moving up the corporate agenda. The EY survey found C-suite executives demonstrating more interest and oversight of tax in 75% of companies with annual revenue of more than US$100 billion.7
“More often than not, we're talking to CFOs on this topic,” says van der Graaf. “Most tax directors aren't necessarily acquainted with tax technology, and since there's all kinds of uncertain tax positions coming out of this that used to be hidden, the issue moves up in to the client’s risk domain.”
If tax authorities are already scrambling to recover lost indirect tax revenue, that’s only exacerbated by the complexities inherent in the rise of e-commerce. Indeed, the digital economy has presented the tax authorities with an enormous challenge: collecting sales tax on goods delivered online and across borders, often through third-parties, where the end taxpayer could be absolutely anywhere.
“Getting hold of those taxpayers, in multiple jurisdictions all round the world, is an enforcement nightmare,” says Kevin MacAuley, EY Global Director of Indirect Tax. “The collection of that lost VAT has been a significant challenge, and one the authorities have been focused on, for many years.”
Thanks to that focus, certain companies can expect to have to deal with even more new laws and regulations. “As always, there’s no silver bullet solution,” says MacAuley. “But it will ultimately involve passing the responsibility for tax collection to the major e-commerce providers that process these transactions. If they don't collect, if some of the people selling through their platforms are not accounting for VAT, then those providers will have to pay.”
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Chapter 4
Know your customer
More transparency obliges financial institutions to report more detail about their customers’ activities.
Transparency is also intensifying in customer tax operations. Organizations, primarily in financial services, are required to report on their customers’ income and tax obligations, and potentially withhold tax to reroute it to the authorities.
“FATCA and CRS placed a huge burden on financial institutions, which suddenly had to perform a tremendous amount of reporting,” says Ian Bradley, EY Global & Americas Director of Customer Tax Operations and Reporting Services (CTORS). “Any mistakes or failures were on them, the penalties very severe. Some very large institutions spend $50m+ simply maintaining the headcount, technology and systems to comply with those responsibilities. There’s a never-ending ask from different regimes for the banks to report more. And there are always more regimes and rules coming along.”
This places yet more pressure on companies in terms of cost and risk. And these requirements are now spreading to non-financial sector companies, notably those in the digital economy – whether that’s an online property rental service reporting on its "hosts", or a social media platform filing financial reports on its influencers.
These companies must deliver ever-more detailed customer data in order to remain compliant – without negatively affecting the customer experience.
The answer is to develop an enterprise-wide approach to compliance, with a seamless end-to-end flow of customer data between functions. This means gathering quality data, and building the capability to use it – something that can only be achieved with technology that’s flexible, scalable and able to overcome the internal silos of legacy systems.
“Many organizations are realizing that the ever-growing pressure to have leading classtechnology to fulfil obligations, offer a good customer experience, lower the cost and minimize risk, is in and of itself very challenging,” says Bradley.
Conclusion
When attempting to deal with rising transparency, much of the work of the tax controversy function of the future comes down to one task: achieving certainty. In order to avert the cost and risk associated with increased controversy, the process begins with tax functions getting a handle on their data, as well as what’s required of them, and building the systems to gather, analyze and distribute that data in a proactive manner that has the company keeping pace with the tax authorities.
Yet as it’s unlikely that capturing and reporting data is core to that organization’s existence, those seeking the best way to fulfil their obligations are likely to find themselves streamlining, automating or outsourcing some or all of the process.
Summary
Corporate reporting requirements have undergone a dramatic transformation in the past five years due to a number of new regulations designed to maximize tax transparency. And as tax processes are digitalized and authorities look to bridge the revenue gap, this process is sure to continue. Organizations should manage risk by taking steps such as building their “tax controversy department of the future,” taking a strict data-led approach to transfer pricing and working toward real-time indirect tax reporting solutions to comply with regulations.
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