How to Prepare a Tax Controversy Roadmap for MNE's

Presented by: Prof Dr Daniel N Erasmus

Understanding how to prepare a tax controversy roadmap for multinational enterprises is crucial in managing tax risks. Given the complexities of cross-border transactions, enterprises face significant exposure, particularly in areas such as permanent establishments and transfer pricing arrangements.

This guide, based on insights from the video above will detail the essential steps and strategies to create a comprehensive tax controversy roadmap, ensuring multinational enterprises can effectively handle potential disputes.

Understanding the Tax Controversy Landscape

When dealing with tax controversies, it’s essential to understand the global economic landscape. Different regions exhibit varying levels of sophistication in managing tax issues:

Africa: Represents 3% of the world’s GDP.
India: Accounts for around 12%.
America: Constitutes 25%.
China: Slightly behind America.
European Union: Up to 15%.

These percentages highlight that more developed or developing countries with higher GDPs possess more sophisticated mechanisms for handling tax controversies. Therefore, the approach to tax disputes will differ based on the jurisdiction.

Boardroom Strategies for Potential Tax Controversies

Due to high-level policy issues, predicting tax controversies at the boardroom level is challenging. Effective management requires a dedicated tax steering committee, including:

The CFO
The Head of Tax
Tax advisors
An attorney knowledgeable in tax litigation

This committee should operate under attorney-client privilege to handle sensitive information. Their primary task is to assess and categorize existing tax risks, determining the likelihood of exposure and preparing appropriate responses.

Categorizing and Managing Tax Risks

Tax risks can be categorized based on their likelihood of exposure:

Low-risk items: Collect detailed information and have tax specialists prepare opinions for future audits.
High-risk items: Develop a comprehensive facts and circumstances file, including legal positions and defences.

For significant risks, enterprises may need to engage in voluntary disclosure programs, explaining past mistakes and outlining measures to prevent recurrence. This proactive approach can help negotiate down interest and penalties.

Leveraging Advanced Tax Dispute Resolution Mechanisms

In more sophisticated economies, various facilities aid in resolving tax disputes:

Advanced Pricing Arrangements (APA): Helpful in managing transfer pricing issues.
Alternate Dispute Resolution (ADR): A growing field in many jurisdictions.
International Compliance Assurance Program (ICAP): An OECD initiative for coordinated tax risk assessments through voluntary participation.

However, these mechanisms are more effective in developed economies. Voluntary disclosure programs are more prevalent in regions like Africa.

Preparing for Tax Audits

Developing a robust tax controversy roadmap involves preparing for potential audits. Using transfer pricing as an example, ensure that you have:

Master File: Comprehensive documentation of transfer pricing policies.
Local File: Country-specific transfer pricing information.
TP Studies: Detailed transfer pricing studies with thorough background information.

It’s crucial to document all decisions, methodologies, and justifications, such as why a particular pricing method was chosen. This documentation will support your position during audits and disputes.

Responding to Audit Findings

Once an audit occurs, use the findings to solidify your response:

Factual Responses: Clearly outline where the audit findings are incorrect.
Legal and Guideline-Based Responses: Reference international guidelines like the OECD Transfer Pricing Guidelines.

In developing countries, it’s common to go through ADR before court processes. Thorough preparation for ADR involves running numbers and developing scenarios for potential settlements.

Additional Resources and Publications

Several resources can aid in creating a tax controversy roadmap:

“Tax Intelligence” by [Author]: Provides detailed steps for the tax steering committee process.
“The CFO’s Journey from Staying Out of Trouble to Being Fully in Control”: A summary of tax risk management for CFOs.
“Conducting a TP Trial”: Focuses on preparing for transfer pricing disputes and trials.

Conclusion: Consulting TRM for Expert Guidance

Given the complexities and variations in tax controversies across jurisdictions, consulting a team like TRM (Tax Risk Management) is invaluable. TRM offers expert guidance, helping enterprises navigate the intricate landscape of tax disputes, ensuring compliance and strategic resolution.

References

OECD: International Compliance Assurance Programme (ICAP) – OECD ICAP
Advanced Pricing Arrangements – OECD Transfer Pricing Guidelines
Voluntary Disclosure Programs – OECD Voluntary Disclosure
TPA Global – TPA Global Publications

By following these guidelines and leveraging the expertise of professionals like TRM, multinational enterprises can effectively manage and mitigate tax risks, ensuring smoother operations and compliance across borders.

List of Additional Resources

BOOKS MENTIONED:

DRIVING TAX COMPLIANCE: The Essential Role of the Tax Steering Committee (DOWNLOAD FREE)
TAX INTELLIGENCE (DOWNLOAD FREE)
CONDUCTING A TP TRIAL (PRE-ORDER LINK)
TAX FOR BOARD MEMBERS: CFO’s JOURNEY FROM STAYING OUT OF TROUBLE TO BEING FULLY IN CONTROL

PRESENTATION SLIDES:

Click here to download the slides

LANDMARK CASES MENTIONED:

FULL VIDEO TRANSCRIPT

Thank you for the opportunity to present my topic, how to prepare a controversy roadmap for multinational enterprises is an important one. In the sense that the risk of facing a tax controversy for any multinational enterprise is really, really big when you consider cross-border transactions. There your biggest exposure is going to be in the area of permanent establishments and transfer pricing arrangements. On top of that, you’re going to be faced with tax controversies in different jurisdictions. And I think it’s important to understand the landscape. When you look at the size of the world economy, only about 3 % of GDP emanates from Africa. If you look at india, india is in the region of about 12 % america, 25 % china just behind that in the european union, up to 15 %.

Those percentages tell us that the level of sophistication in dealing with tax controversies is going to be much higher in developed or developing countries where the GDP numbers are higher. That means when facing tax controversies in Africa, you are not going to be dealing with the same level of sophistication. And so, depending on where your emphasis is, that is going to influence the type of approach that you are going to take.

Now, in the boardroom, it’s very difficult to predict what potential tax controversies you may face because you are dealing with very high-level policy-related issues, depending on the information being fed up to the board. How do you take control of potential tax controversies that filters down to the audit committee? Which in itself is not the correct place to deal with this. So that, in turn, requires the creation of a tax steering committee with the participation of at least the cfo the head of tax. The advisers on tax matters to that particular corporation, as well as an attorney or a lawyer with right of appearance, who is knowledgeable of tax litigation, ultimately to share that meeting. So as to create it under the attorney client privilege, because you’re going to be dealing with contentious issues that any revenue authority would love to put their hands. On now that committee will be tossed with looking at existing tax risks. Many of those tax risks may not have been tabled, because you starting at a particular point in time, you would need to bring out into the open what those tax risks are.

So that from there, you are able to determine the tax risk, determine those which are, let’s say, less than a 50 % chance of exposure, those that are more than a 50 % chance of exposure, in order to determine how you’re going to deal with them.

The low risk items, you’re typically going to collect as much information as you can, and have your tax specialists write out an opinion and shelve that with the information ready for a future tax audit on those areas where there is going to be big, potentially bigger exposure, where it isn’t clear cut that what you have done is correct. That will obviously require a facts and circumstances, file, build up, opinions or input as to what your legal position and defenses are to that particular tax risk.
And then, depending on how big the risk is, if you’ve clearly done something wrong, you now need to find a way of approaching the revenue authorities under a voluntary disclosure program, or a similar process whereby you’re able to table what you’ve done. More importantly, explain not only what you’ve done wrong, but what you did wrong. How did you find that you’ve done this wrong? And more most important? How are you going to ensure that this will not take place in the future? And this is how you propose dealing with it. Hopefully you’re in a position where you can talk down any interest and penalties, which I have an experience that is what has happened in the past where you go cap in hand, depending on the revenue authority you’re dealing with. And in order to resolve those issues.Now there may be issues where you do, not think that you do not think that you don’t have a major exposure in the sense that you feel your defenses are pretty solid. Yet, you don’t want to take the risk of keeping that exposure out there. Then in the more sophisticated economies, you are going to be able to take advantage of various facilities that are available to you. That would be areas such as advanced pricing arrangements in transfer pricing. Various jurisdictions are developing in the areas of alternate dispute resolution.

And then another very interesting area that has been developed by the oecd is I cap icap I kept stands for the international compliance assurance program, and as I mentioned, is an initiative developed by the oecd which offers multinational enterprises a coordinated approach to tax risk assessments by encouraging a voluntary participation by that corporation as well as the tax administration in order to address a particular tax risk.

Now, before going down those types of avenues, you wanting to make sure that the time frame in which you can wrap up this particular potential controversy are going to be short. If it’s gonna be a very protected process, then you’re better off probably waiting for the better to go the normal tax dispute route. Instead of deciding on the I kept process. But as mentioned, I cap will typically only work in your highly developed economies or jurisdictions certainly are not aware of that type of process working in the african environment.

In the african environment, you would very much be looking at a voluntary disclosure program if you are definitely wrong, if you’re not definitely wrong and you’ve got a good defense, you better off documenting all of that information together with the various opinions to back you up as to why you’re not wrong, and then wait for the opportunity to take that up in any tax controversy that might then develop into the future.

That means you need to develop your file, your roadmap, and your travesty roadmap in preparing for a tax audit because the chances are that this may come up in the future. And I want to use transfer pricing as an example. So, typically, you would have your master file, and you’d have your in-country or local file. You would have filed various tp studies. You must obtain as much information as you can in respect of those files, particularly the background notes, information, discussions, interviews that took place in determining what your transfer pricing study should look like. Because all of that is going to inform why you decided upon, let’s say, the resale price method versus the TNMM method, or why you didn’t take advantage of the cup method. Those are extremely important facts, because you’re going to be questioned on why what you did. The revenue authority is typical, typically going to, in instances, take the information that you’ve researched the comparability information that you’ve obtained and manipulate that information without performing their own study in order to come up with their own version.

For instance, you might have done on a resale price method, atp study. They will take the companies that you looked at, exclude a bunch of them for various reasons and then utilize those companies to do. Atnmm study to say that the operating profit method is more suitable than the growth. Gross margin, gross margins, in order to determine what an arms length price is. And you are only able to refute what they have done on their tnmm study by being able to motivate very, thoroughly and carefully. What you did with the resell price methodology based on a gross margins. Here, the preparation of the factual file together with anything to support that is of great importance. Once the audit has taken place, they are going to give you electoral findings, and that is an opportunity now to solidly respond. To the facts, show them where they wrong, show them how the facts should be looked at differently.

And also then to convince them not only in terms of the law but in terms of any international guidelines, such as the OECD transfer pricing guidelines, to do so. And based on that’s going to inform you where this may end up, in your typical developing countries, you will usually be given a responsibility to go to adr before the actual tax court process starts. There, once again, you want to put your best case forward, also looking at opportunities to settle the matter with the revenue authority. You would be thoroughly prepared, and going to the ADR, you would run your numbers to look at potential scenarios for settlement. It’s not just a thumb suck in terms of the dollars that you would put out there, and you would motivate your particular position and a dollar amount that would be appropriate for the adr and a settlement.

As far as more detailed information goes, a booklet link summarizing the tax steering committee process, based on another book I published some years back called Tax Intelligence, was made available to you. If you reach out to me, I’m more than happy to give you a PDF copy of that at no charge so that you can dive deeper into it.

Then, at TPA Global, we also published a booklet called The CFO’s Journey from Staying Out of Trouble to Being Fully in Control, which is a good summary of what an ACFO should be doing to stay in control of tax risks. It obviously segues into creating the necessary roadmap for a tax controversy process.

And then, of late, I’m publishing a book called Conducting a TP Trial, which looks into all the preparation needed if you anticipate going to trial on a transfer pricing dispute. These are steps that you should, in any event be taking in and through the tax risk steering committee. If you have any further questions, please do not hesitate to contact me. The contact details are on the slide deck made available to you, and I trust that you will be successful in your endeavours.