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September 2010 
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Tax Disputes |
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Muazzin Mehrban, August 2010 |
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With global authorities keen to fill their account deficits, is this the dawn of a new era in tax related disputes? Experts suggest this is a real possibility. Over the past two years, taxpayer appeals against tax authorities have risen around the world, which is likely to lead to increased tax related litigation. In addition, new legislation is being introduced by tax authorities at an alarming pace, which always carries the possibility of sparking conflict with those companies hit hardest by regulatory change.
Not only is the number of disputes rising; the variety of disputes is also expanding. Disputes can involve issues like financing arrangements, which include loan and interest arrangements resulting in beneficial tax treatment. Also, transfer pricing issues related to intellectual property, guarantee fees and supply chains are also cropping up. Arrangements to secure tax preferred payments to employees, as well as various forms of mass-marketed aggressive tax planning arrangements have come to the fore.
Even the constitutionality of certain taxes or government charges has been challenged in various countries. According to Daniel Sandler, a partner at Couzin Taylor LLP, “in Canada, the main tax disputes faced by companies – in terms of dollars in dispute – are transfer pricing and aggressive tax planning. Both types of cases are on the rise. In a recent survey, 75 percent of businesses indicated that audit activity is on the rise and 50 percent of businesses indicated that the Canada Revenue Agency (CRA) is more aggressive than any other tax authority.”
In emerging markets such as Brazil, tax related activity has raised several important tax questions pending resolution by the higher courts. Among these cases, there is the discussion over whether social contributions can be charged on exports, because as it stands, the Federal Constitution of Brazil exempts export revenue from taxation, as a means of strengthening the country’s trade balance. “The issue hinges on the legal classification of social contributions, which are levies whose revenues are earmarked for specific purposes rather than going into the general fund,” explains Luiz Gustavo Bichara, a partner at Bichara, Barata, Costa e Rocha. “The Federal Revenue Service takes the position that they do not fall under the constitutional definition of taxes. This matter is pending analysis by the Supreme Court. Another case with great repercussion pending decision by the Supreme Court is the constitutionality of a law that determines that the equity pick-up of Brazilian companies from foreign subsidiaries and other overseas equity holdings is subject to income tax,” he adds. Taxpayers have argued that taxation should only be enforced when gains are realised on these investments. Of the 11 Supreme Court justices, four have already voted to declare the law unconstitutional, while two have voted to uphold it.
The role of authorities
In Canada, although there have been few transfer pricing cases to date, there has been a significant increase in transfer pricing audits by the CRA. With the number of audits increasing, there will inevitably be an increase in tax related litigation. Two transfer pricing cases are currently on appeal to the Federal Court of Appeal and there are a number of transfer pricing disputes currently in the pipeline. As the government looks to slash its budget deficit and at the same time maintain or reduce corporate tax rates, there is plenty of pressure on the CRA to ensure a steady stream of incoming tax revenues. Large businesses have felt the brunt of increased audit activity due to the large adjustments that such audits can generate. In addition, the CRA has recently brought the ‘basic file’ corporate audit population (businesses with annual revenues of $20 to $250m) under the same audit approach used for large businesses, so that these businesses are now risk assessed for possible transfer pricing and aggressive tax planning audits as well.
On the other side of the Atlantic, the UK has seen growing uncertainty in recent years due to complexities in tax and VAT legislation. “The ongoing and frequent changes in the tax regime have fuelled litigation where tax planning structures have been put in place,” says Liesl Fichardt, a partner at Berwin Leighton Paisner LLP. She also points out that Her Majesty’s Revenue and Customs (HMRC) has adopted a more aggressive stance in recent times. “That is matched by taxpayers who have gained increased confidence in challenging HMRC, following many successful claims in recent years. Significantly, a reputational shift has taken place – previously, taxpayers were reluctant to be seen to be involved in disputes with HMRC due to, amongst other things, reputational issues. However, taxpayers’ successes have resulted in confidence and willingness to litigate where it is justified by a cost benefit analysis,” she says.
Meanwhile, in Brazil, tax authorities have also become more effective in their monitoring actions. They have improved the training of tax inspectors to detect alleged irregularities, for example. The government sees this as the best way to increase revenues without having to pass new laws that may prove unpopular, especially given that tax rates are already high. Furthermore, improved information technology means that tax authorities, even in emerging markets, have virtually unlimited access to financial and accounting information on companies. But the methods adopted by tax authorities have been described as overzealous at times, leading to questionable tax deficiency and infrastructure assessments, which in turn can trigger litigation.
Brazil has recently undergone an important regulatory change, increasing the social security contribution to cover work-related accident compensation. While it was established with the credible intent of increasing the amount that companies spend on safety – as the rate is tied to accident statistics – the increase has placed a bigger burden on the vast majority of companies. In addition, many feel that they are being unfairly punished as the rules over what applies are neither clear cut nor evenly applied. The result has been a wave of administrative appeals and lawsuits, as well as lobbying for policy change.
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