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Tax directors say they are feeling more pressure as tax authorities' transfer pricing audits become more aggressive and detailed.
Due to the increased amount of data available from corporations, tax authorities are moving toward targeted risk-based TP audits aligned with OECD standards. Businesses must remain proactive in preparing TP documentation and maintaining inter-company agreements, according to tax directors and lawyers, to avoid similar disputes to those involving Maersk and ConocoPhillips in Denmark and Norway, respectively.
Jakob Krogsøe., a partner at Bech-Brunn and the lawyer representing the Maersk group in its TP case against the Danish tax authority, told ITR that the recent tough stance taken by tax authorities has surprised some well-known corporations.
"If you spoke to my litigating colleagues who have led or conducted these high-profile TP cases," Krogsøe said, "they would probably conclude that the approach from the tax authorities is quite aggressive."
Because businesses are sharing more data and more information is available through information exchanges, tax administrations are conducting audits in a more focused and stringent manner.
"They are putting quite a lot of effort into creating or developing new allegations, new ways of assessing or trying to build the case. They have no restrictions or concerns with respect to how old the information is ," Krogse explained.
Significant investments
Many tax authorities are putting significant resources into departments dedicated to auditing and evaluating TP arrangements.
According to Ane-Ingeborg Bakken-Simsoe, a senior associate at RSM Norway, Norway's "focus has been strengthened" and the tax authority has "a lot of projects concerning TP."
"The Norwegian tax authorities have made TP a priority and have built up a specialised department to focus on TP issues," Hanne Skaarberg Holen, partner at EY Norway, explained. "They are looking for easy wins where the TP documentation is flawed or inadequate," Holen continued, "but have also attempted to argue very simplistic cases."
“One of the goals is to strengthen the TP environment with more specialists, which in turn leads to better risk assessment and more accurate prioritisation in TP cases,” according to Bakken-Simsoe.
According to Holen, the tax authority is looking into recurring losses that could be evidence of mispricing. It is also looking into Norwegian companies that it thinks should get more of the non-routine profits generated by foreign subsidiaries.
While the welfare systems in Norway and Denmark are to blame for the tax authorities' strict stance on TP, the UK has also stepped up its TP documentation game, with plans to align its requirements with OECD standards by 2023. Taxpayers will be able to improve the quality of their documentation and reduce the risk of TP disputes by using the summary audit trail.
Risk-based transfer pricing audits
According to Philip Roper, global TP services at KPMG UK, tax authorities are succeeding in defending adjustments in court.
The rise of additional reporting requirements and regulations, such as the uncertain tax treatment notification regime, which covers TP uncertainties, and the UK's profit diversion compliance facility, which notifies taxpayers of potential audits, has been noticed by Roper as a clear theme.
"The big picture we are seeing is a shift towards more targeted risk-based transfer pricing audits in developed economies which reflects the increased data available to tax authorities on the largest multinationals to make these assessments," according to Roper.
"In developing countries, we are still seeing a lot of audits on more basic issues such as deductibility of cost-plus intra-group service fees and benchmarking returns for routine local marketing, distribution and manufacturing functions and how these are applied on a year-by-year basis," he said.
Risk control and DEMPE, which are part of the OECD's 2017 TP guidelines, are being adopted by tax authorities. According to Roper, TP court cases are arising as a result of "interpretive issues" resulting from BEPS changes to the TP guidelines. Due to "unfinished business" with the original BEPS risk control work, he expects this trend to continue in future TP litigations.
To avoid potential litigation and protect themselves from TP adjustments, corporations must have thorough TP documentation, as well as carefully worded inter-company loan agreements. Quality should take precedence over quantity, with the depth of evidence explaining a company's TP method and the specific circumstances under which the pricing was conducted.
"Given how often people change jobs these days, the challenges of accessing old records and knowing the limits of my own memory, it really does reinforce the importance of capturing the relevant facts at the time to be in the best position to defend your transfer pricing down the track," Roper said.
"Documentation is critical, and the importance of circumstantial evidence cannot be undermined," Seema Kejriwal Jariwala, a partner at BMR Legal Advocates, agreed.
Smaller businesses that are rapidly expanding and are unfamiliar with the risks of international taxation must be aware of all the different local tax regimes within the same country. Because Denmark has few large companies, small and medium-sized businesses (SMEs) may be subjected to more TP audits in the future.
"You have to be really cautious and aware of how you create your TP documentation because, a least from a Danish perspective, is it a key document to avoid an audit or dispute" Krogsøe said.
Although tax directors and lawyers are aware of the IRS's increasingly strict approach to TP documentation requirements, corporations must remain proactive when conducting TP analyses and ensuring that inter-company agreements are kept at arm's length. No taxpayer is immune from a thorough TP audit, especially if they are based in an OECD country.
By fLEXI tEAM