Communication with peers, especially on how to approach regional authorities, is important for risk management, according to tax leaders.
Netflix and other multinational companies' tax departments say they continue to benefit from long-standing relationships with other in-house teams by using their advice on global tax risk management to navigate audit defenses in other countries.
Tax teams need relationships based on information sharing because audits are becoming transactional rather than interpersonal, and most tax authorities are moving to data-driven compliance. According to tax leaders, this makes it more difficult for tax teams to disclose unusual business structures that affect their company's tax position, and it leads to aggressive questions from authorities.
Sonja Schiller, Netflix's global head of tax controversy, based in Seattle, says it may be necessary to maintain contact with tax teams in order to prepare for future audits.
"Industry sharing can be very valuable especially in a TP context where your business model aligns with other taxpayers’ business models," says Schiller.
"Reviewing developments in case law along with anecdotal reports of audit experiences from other tax teams helps to measure risk," she adds.
According to reports from advisers at the 'big four' accounting firms, tax teams will face even more pressure in the coming months as the frequency of large corporate audits rises in most parts of the world. Brazil and India already have record-high levels of tax litigation, and Latin America and the Asia-Pacific region have some of the most powerful dispute resolution teams.
Other tax teams can advise on how to prepare for incoming digital audits, negotiate advance pricing agreements, and manage other legal matters in foreign countries, so sharing information with other tax teams is an important part of assessing risk.
According to a recent KPMG survey, most tax teams reassess their risk every quarter. Nonetheless, all of the tax directors who spoke with ITR agree that at least some tax authorities are conducting more audits this year than in previous years, and that tax uncertainty continues to affect their data-driven compliance processes.
Companies are being targeted by tax administrations based on data analysis of their risk factors, which range from transactions to permanent establishment issues, some of which are discovered during routine information exchanges with other authorities. The audit is enhanced by additional information.
Because of an increase in desk-based audits – meaning remote, data-driven investigations – during the COVID-19 pandemic, audits are more transactional than relationship-based. Many of these have persisted in recent months, and tax departments are also using in-house analytics to manage risk.
According to Jed Larkin, senior vice president of tax at 3M in Minneapolis, his in-house software compliance tools can access multiple levels of historic audit data, and the system is managed by tax technologists to address data-driven compliance.
"I think you can prepare ahead of time for audits by knowing your major transactions, going through annual reports and public filings, and reviewing any major restructurings, litigation, and settlements that have tax implications," says Larkin.
"You need to have a central place to store those materials and access them," Larkin adds, "because making sure you have material accessible can ease the pressure when the audit starts."
Some tax professionals have noticed a clear theme of increased expectations for transparency and cooperation among authorities, which is a trend in most countries with additional reporting requirements and regulations such as the profit diversion compliance facility, which alerts taxpayers to potential audits.
Tax directors say they are under more pressure than ever before as global audits become more aggressive and detailed, thanks to data-driven insights. Because interpersonal relationships with authorities are less common, tax controversy leaders are having difficulty deciding whether to take a proactive or reactive approach to audits.
In fact, tax directors rely on market rumors to figure out how to deal with authorities in different countries and avoid audit risks, because different tax administrations interpret international laws differently.
Erin Gladney, senior director of global tax disputes at Johnson & Johnson in New Jersey, says she learned about the retirement of several members of the Internal Revenue Service's audit examination team from colleagues. She also mentions that her audit risk profile may change as a result of the tax authority's recent hires' lack of experience, particularly with regard to transfer pricing (TP) issues.
Despite many countries aligning local rules with OECD standards, desk-based audits continue to cause TP controversy. Even the three largest tax administrations in terms of size, the United States, the United Kingdom, and Japan, have differing views on capital valuation. Because of these and other differences, businesses must take a flexible, global approach to tax planning.
More court cases are being filed, according to Philip Roper, global TP services at KPMG UK, because of "interpretive issues" in audits resulting from the 2017 BEPS changes to the TP guidelines. Due to "unfinished business" with the BEPS risk control work, he expects this trend to continue in future litigation.
Schiller divides her own process for assessing tax risk in audits into two parts. Before assessing liabilities that could expose the company to criminal risk, she looks at national court interpretations of international law and the most recent local tax policies.
"You can see countries threatening criminal litigation as a tool to resolve settlements," says Schiller, who has seen tax authorities win more often in TP litigation when arguing over arm's-length prices for intercompany transactions.
According to advisers, tax administrations are conducting audits in a more focused and strict manner as a result of a greater amount of data being shared by businesses through country-by-country reports (CbCR). Information exchanges between authorities make even more data available.
CbCR reports are increasing audit activity in India and other Asia-Pacific countries, according to experts at the 'big four' firms, but the increase is not as high as expected.
Not all taxpayers are concerned about CbCR-backed audits; in fact, some argue that the worst-case scenario is that investor relations groups scrutinize financial reports using newly available public data. Taxpayers continue to follow the advice of centralizing data and maintaining a narrative.
"You don’t want to be reactive all the time," Gladney says, "and the most proactive approach is to have a good grasp of where your documents are saved so you are not scrambling to leverage your material."
In order to achieve long-term success in audit defense, data taxonomy is becoming increasingly important. Regional tax authorities should only have access to the group's data from their region, according to tax directors, unless there are legal requirements for the group to share documents on tax positions in other countries.
"If we are able to implement upgrades in the right way then our team could have much better visibility on the business’s documentation and security on their read, write, and edit access," Gladney adds, adding that local tax administrations should be limited in their access to documents from other countries.
With the rise in desk-based audits and increased government vigilance, tax directors are discovering that sharing examination experiences with other teams is assisting them in strengthening their defense strategies.
However, not all data-driven investigations are the same, and tax teams must find colleagues in similar business structures and regions in order to be confident in their knowledge of how to prepare for future data-driven investigations.
By fLEXI tEAM