By: Diane Ring
In a post earlier this week, I considered how the international tax conference I was attending (the annual worldwide meeting of the International Fiscal Association, IFA) had something in common with the Japanese anime and manga conference hosted in the adjacent venue. Soon the anime event ended and the tax conference continued, but with a new neighbor – the Meteorological Technology World Expo 2016. No costumes – but some interesting, though puzzling, equipment outside in the courtyard. I thought about the big task of meteorology—predicting the future. Turns out that in-house tax advisors have the same job, it’s just that instead of rain, they predict the tax implications of business decisions for the C-suite. But the tax advisors do it without the tech, and there is a lot to keep them up at night . . .
During an afternoon conference session, a group of in-house tax counsel participated in a roundtable conversation about their major tax worries in the uncertain world of international tax. I found their list reflected an interesting mix of risks that they must assess in trying to predict their corporations’ tax future.
At the top of the list were the potential risks surrounding the worldwide implementation of the new BEPS Action 13 country-by-country (CbC) reporting (and the accompanying Master file and Local file). Pursuant to new CbC requirements, large multinationals must complete a template providing seven categories of data for each country in which they operate. This report will then be shared with all of the countries in which they have a taxable presence (assuming certain data privacy and other protocols are met by the jurisdiction). The CbC data categories include revenues (both from related and unrelated party transactions), profit before income tax, income tax paid (cash basis), income tax accrued (current year), stated capital, accumulated earnings, employees, and tangible assets. So, what are the worries prompted by this new regime?
The answer is a mix of operational, audit, and commercial concerns.
On the operational side, advisors seek to determine the level of resources needed to cover compliance costs for businesses that don’t currently maintain the specific version of information required in the CbC report. Advisors are also are trying to anticipate additional compliance costs that will be incurred if countries seek more and different information once they receive the CbC report and Master File.
On the audit front, advisors worry that government audit teams: (1) will draw negative inferences from any differences between the corporation’s financial reporting and it’s CbC report (even though the documents answer different questions according to different requirements; (2) might (illegally) divulge taxpayer information; (3) might expect a very formal division of employee functions (for purposes of determining how much can be taxed in the country) while in real life employees often engage in work across formal lines; (4) might face so much public pressure to be tough on multinationals that it becomes impossible to negotiate with the taxpayer and with other jurisdictions to prevent double taxation; (5) will be tempted by the availability of the CbC data to make a quick adjustment without doing the work required to fully understand the taxpayer’s transactions; (6) will explicitly or de facto use formulary apportionment (aided by the data in the CbC report on revenue, employees and assets) to allocate income in related party transactions, despite exist law and/or treaties to the contrary; and (7) will not be the only source of risk for a big tax bill (the recent Apple EU state aid decision made clear that even if a country is fine with your tax compliance, another body might step in and demand back taxes).
Finally, the in-house tax advisors noted a range of commercial or business concerns arising out of CbC reporting. First, they worry about public disclosure of the CbC reports. Although the deal struck at the OECD to garner support for the introduction of CbC reporting required that the reports be confidential, the in-house advisors see two great risks going forward: (1) hacking or other illegal acquisition of the data (especially given the large volume of data that many countries will have once the delivery of CbC reports commences); and (2) a decision by an individual country (e.g., the United Kingdom) or by a regional group (e.g., the EU) to require that CbC reports (or other data) be made public. Public disclosure can cause two kinds of harm: (a) public reputational risk (for example, the story of Starbucks and consumer fallout from public disclosure of information about Starbucks’ (limited) tax payments is a story that the business side of the multinationals know well); and (b) de facto disclosure of trade secrets or other proprietary business information to business competitors (because such competitors can sift through disclosed information in a CbC report and/or accompanying Master File, to forensically reconstruct valuable proprietary information).
Second, the advisors worry about the realities of gathering and organizing this data inside the company. For many businesses, this may be the first time that such information has been comprehensively collected and organized internally. Given the scope of the reporting obligation and the amount of non-tax information that must be gathered (e.g., employee count), a large number of employees across divisions would be involved in the process. This widespread participation has led to concerns that such workers could leave the business and head to a competitor, bringing along a valuable picture of the entity’s global operations that emerged from the CbC and Master file data collection process.
Substantive tax issues
Separate from the specific issues surrounding the CbC reporting requirements, tax advisors worry about hot spots in international tax law, especially permanent establishments (“PEs”). Under most tax treaties (and domestic tax law), if a taxpayer has “enough” of a business presence in a foreign jurisdiction, then that country may tax it on a net basis on its income earned there. Increasingly, countries have been somewhat “aggressive” in finding PEs, so tax advisors worry that even when they don’t believe they have a PE, the tax authorities will deem there to be one. Relatedly, the advisors also list unresolved double taxation (whether from an aggressive finding of a PE, from transfer pricing, or from other conflicts) as a challenging risk to manage. But they see some double taxation as inevitable given that accounting and transfer pricing rules vary across the globe and there is no simple way to reconcile all of these differences.
Common thread across the risks
But all of these uncertainties have one thing in common–the tax advisor is supposed to quantify the nature of the risk so that the business side can incorporate the information into their planning process. How can that be done? It’s not easy. Certainly when tax lawyers prepare opinion letters they are reaching a conclusion about the strength of their opinion and the likelihood of success on the merits. But trying quantify the risk to a business that, for example, CbC reports will be made public, is a different matter. The roundtable consensus seemed to be that tax advisors are telling their businesses to be prepared for data to go public. A bit like the meteorologist suggesting you bring an umbrella– just in case.