Q&A: Managing and resolving cross-border tax disputes
November 2018 | SPECIAL REPORT: CORPORATE TAX
Financier Worldwide Magazine
November 2018 Issue
FW moderates a discussion on managing and resolving cross-border tax disputes between Eduardo Gracia at Ashurst LLP, Chris Kinsella at MinterEllison, and Richard Jeens at Slaughter and May.
FW: How would you characterise the frequency and nature of recent tax disputes? What factors are driving them?
Gracia: In Spain, the frequency of tax disputes is high and they affect mainly multinational groups and large companies. The main factor driving this high level of litigiousness is the need for continued growth in tax collections to fund new social programmes in the wake of Spain’s recent financial crisis. For this reason, the Spanish Tax Administration focuses on those groups of companies that, due to their size and financial strength, are more likely than others to have the cash and financial solvency to pay to the treasury, even though undeclared money tends to be concentrated in small and local businesses.
Kinsella: The Australian Taxation Office (ATO) is trying to be more disciplined in the cases it runs, focus on public interest, intractable disputes, egregious behaviour and whether there is a precedent to be set in relation to a particular tax issue. The result is that recently there have been fewer tax cases than in the past. In the last financial year, there were 230 tax cases, two-thirds of which settled. Of these, about 80 percent were favourable to the Commissioner of Taxation, 10 percent were partly favourable and 10 percent were adverse. Approximately two-thirds of cases were in the Administrative Appeals Tribunal (AAT), with about 80 percent favourable to the Commissioner. Twenty percent were in the Federal Court – about 67 percent were favourable to the Commissioner – and 13 percent were in the Full Federal Court with about 85 percent favourable to the Commissioner.
Jeens: Tax disputes have become more intense, more frequent and more international over the last few years. Part of this has been a result of the political and public pressure on tax authorities across the world to tackle perceived ‘tax avoidance’, whether driven by ‘Lux leaks’, the ‘Panama Papers’ or domestic political agendas. However, part has been a result of enhanced powers for tax authorities, such as the UK diverted profits tax regime revisiting past cross-border transactions and forcing taxpayers to pay the tax in dispute up front, as well as enhanced cooperation between tax authorities, such as the information exchange agreements agreed post-Organisation for Economic Co-operation and Development’s (OECD’s) base erosion and profit shifting (BEPS). From a European perspective, there has also been the increased focus on whether rulings or arrangements agreed historically in good faith remain valid under state-aid rules. Together, this has led to a lack of certainty in the tax landscape and an increase in disputes.
FW: How would you describe the nature of the tax processes, provisions and enforcement in your jurisdiction, and the extent to which they contribute to the level of cross-border tax disputes?
Kinsella: In Australia, the taxpayer has the onus of proof in relation to tax disputes. The taxpayer can challenge a tax assessment before either the AAT or the Federal Court. The Commissioner has several enforcement powers that allow him to obtain information in relation to cross-border tax disputes, for example through numerous exchange of information agreements with other revenue authorities or through section 264A notices, which contain a significant evidential sanction if not complied with. The Commissioner can also enforce the collection of tax from assessments, for example through withholding provisions on vendors in transactions or through garnishee notices. Recent law changes have given greater powers to the Commissioner, for example Australia’s transfer pricing provisions were significantly strengthened in 2013, changes were made to Australia’s anti-avoidance laws in 2016, a diverted profits tax was introduced in 2017 and soon an extensive law will be introduced in relation to cross-border hybrid mismatches. The Commissioner also had a very significant win in the Full Federal Court in 2017 in the landmark Chevron transfer pricing case.
Jeens: Both the UK tax authority and the supporting court and tribunal system remain politically independent and committed to the fair and effective resolution of cross-border tax disputes. Further, the governance of disputes with Her Majesty’s Revenue and Customs (HMRC) has tightened markedly in recent years, arguably to the point where it lacks the flexibility to reach the best outcome as quickly as possible. That is, of course, understandable and appropriate in ensuring a level playing field for taxpayers, whether domestic or international, and many of the processes and provisions relating to enforcement in the Litigation and Settlement Strategy (LSS) framework are designed to ensure that HMRC or the relevant tribunal has all the evidence needed to make an informed decision on the tax payable. However, as some of the responses to the recent HM Treasury Sub-Committee inquiry into tax enquiries and disputes shows, there can be too much focus on information gathering prior to, or without sufficient time being spent on, understanding the substantive legal or technical issues. This can contribute to an increased number and duration of cross-border disputes, as inevitably authorities in each jurisdiction feel the need to consider the same pool of information. The key for taxpayers in managing a cross-border dispute is, therefore, to be proactive in identifying the issues at stake and an appropriate process to deliver the relevant supporting evidence in a cost-effective manner, whether to achieve settlement or victory in court.
Gracia: Spain is a very formal and highly regulated jurisdiction, particularly in terms of its tax processes, the powers of the Tax Administration and the rights and obligations of taxpayers. It must also be noted that in Spain there is no chance of reaching a settlement at any stage, be it at the administrative or court level, unlike in other jurisdictions, and the authority’s power to review taxpayers extends for a long period of time. Indeed, a review can take four or five years, first by the Tax Administration and later by the first compulsory administrative court instance. The characteristics of Spain’s tax procedures may generate more litigation than other EU and Western countries where tax processes differ.
FW: What are some of the typical issues and challenges facing companies involved in a cross-border tax dispute?
Gracia: The cross-border issues that are mainly subject to tax litigation are those related to the substance of the companies that acquire assets or invest in Spain, transfer pricing in cross-border transactions and permanent establishments. The main problem that companies involved in cross-border tax disputes in Spain have to face is that Spanish courts are not sufficiently prepared to deal with technical issues of an international tax nature.
Jeens: The two key issues in any dispute are persuading the tax authorities in question that your view of the relevant law is right, or at least an acceptable interpretation, and providing the evidence to support your view of the relevant facts. Practically, the burden on both counts tends to land on taxpayers, but tax authorities have increasingly used data available from other authorities to assist in disputes. One recent example of this has been the detailed use of international arrival and departure data in transfer pricing, residency or permanent establishment cases. Individuals have perhaps been used to ‘counting days’ for domicile or residence for some time, but this sort of data mining makes the evidential analysis or witness questioning in corporate tax investigations and disputes much more granular and places a burden on taxpayers who may not have detailed historic calendar data. Quickly getting on top of the legal issues and what will be needed, and what is available, to support a taxpayer’s case is critical to mitigating the practical and substantive challenges in a cross-border dispute.
Kinsella: Common to most cross-border tax disputes is the ability to procure sufficient evidence, including expert evidence, to prove one’s position. Specifically, there are invariably challenges in procuring the right documentation and the right people; this includes lay people involved in the particular transaction and the right people to act as experts. The ATO has foreshadowed that greater transfer pricing disputation will be likely in the future, particularly concerning cross-border, related-party financing and the establishment of marketing or procurement hubs in offshore locations. The Commissioner recently issued a broad ranging practical compliance guideline in respect of related party cross-border debt, following its win in the Chevron transfer pricing case. A key issue in cases is the question of hypotheticals; that is, what are the consequences of imposing arm’s length conditions on the transaction where the actual conditions differ from arm’s length conditions?
FW: Which dispute resolution processes tend to be available to companies embroiled in a cross-border tax dispute? How should a company evaluate their suitability and applicability?
Jeens: The classic process in the UK involves a period of enquiry or investigation by HMRC, followed by potential litigation before the tax tribunals or appellate courts if an agreement cannot be reached. For cross-border issues, there may be the option of the mutual agreement procedure (MAP) under the relevant treaty. In some instances, mediation or another form of alternative dispute resolution (ADR) is available but, especially for the larger scale or more technical disputes, this is unlikely to be effective. Practically, the key for most taxpayers is to find possible technical solutions and supporting evidence that address the concerns in each relevant jurisdiction with a view to achieving a resolution that works for all the relevant tax authorities.
Kinsella: There are a number of options available to a taxpayer that has an actual or looming cross-border tax dispute. Since 2013, the ATO has been conducting independent reviews of significant matters for large taxpayers to test whether the ATO audit teams have taken the correct approach. A significant number of taxpayers have been able to avoid disputes by going to independent review at a relatively early stage in the lifecycle of a dispute. The ATO also has a separate anti-avoidance review panel. The ATO is amenable to ADR procedures, including early neutral evaluation and mediation or negotiation. There are also mutual assistance procedures available under treaties. The final option is to pursue litigation in the AAT or Federal Court. The suitability and applicability of these different options must be determined on a case by case basis; they will depend on the taxpayer’s appetite for issues around cost, time, materiality, reputation risk and the ATO relationship.
Gracia: In addition to the domestic tax procedures, companies that are involved in cross-border tax disputes have a number of alternative procedures for the resolution of those disputes, including the MAP procedure provided for in the bilateral tax treaties, the arbitration procedure provided for in the Arbitration Convention, the new arbitration procedure provided for in Directive 2017/1852 of 10 October 2017 on tax dispute resolution mechanisms in the EU, and the arbitration procedure provided for in bilateral tax treaties, in particular after the entry into force of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI). Such alternative procedures can drag on for an extended period of time before termination, but in any case they take less time than domestic ones. In addition, they guarantee the elimination of double taxation and the resolution-makers have expertise in international tax matters. For all these reasons, it is worth considering these dispute resolution procedures which are specific to cross-border tax disputes.
FW: What do you consider to be the pros and cons of pursuing litigation to resolve a cross-border tax dispute?
Kinsella: There are a number of pros of pursuing litigation to resolve a cross-border tax dispute, such as setting a precedent and clarifying law. In addition, an independent and objective evaluation will be made of the matter, there will be certainty of outcome, as well as a finding for both the taxpayer and the ATO. There is also a formal legal process for the conduct of the dispute. The cons of pursuing litigation to resolve a cross-border tax dispute include cost, reputation risk, legal and factual litigation risk, and the likelihood of appeals
Gracia: The main advantage of litigation is that sometimes the domestic tax procedures are the only alternative that companies have when serious sanctions have been imposed. Thus, the EU Arbitration Convention, as well as, generally, the new tax treaty arbitration under the MLI, is inapplicable in the event that the taxpayer is liable to a serious penalty by actions giving rise to an adjustment of transfers of profits. The main drawbacks of the domestic tax procedures are the lengthy duration to resolve the dispute, a lack of expertise among judges in international tax matters and the fact that elimination of international double taxation is not guaranteed.
Jeens: Litigation can be time consuming and expensive, and the publicity can be damaging to a business’ reputation, especially given the difficulties of explaining or justifying tax issues in public. Nonetheless, the UK has a strong court system that we have seen deliver certainty and positive outcomes for taxpayers, whether in clarifying relevant provisions of domestic law, for example to secure benefits under applicable tax treaties, or in accepting the anticipated effect of complex cross-border transactions.
FW: How significant a role do expert witnesses play in the resolution of a cross-border tax dispute? What are the advantages and disadvantages of introducing an expert into the process?
Jeens: The role, and value, of expert evidence varies enormously. In some cases, it can be a real advantage to have an independent expert available, whether in persuading the relevant court or tribunal or in finding a way to settlement with the particular tax authorities. For instance, transfer pricing disputes will almost inevitably require some economic evidence, alongside the underlying factual evidence. Likewise, technical disputes about how the tax provisions of one jurisdiction should be interpreted in another are likely to need expert input. What can be less helpful, and costly to all parties, is over-reliance on experts trading theories in too partisan a manner or experts attempting to address issues beyond their real expertise. Time spent testing experts in advance, and thinking how they will help resolve the dispute, is rarely wasted.
Gracia: The role of expert witnesses is fundamental, both in domestic procedures and in alternative dispute resolution (ADR) procedures. However, expert witnesses have a particularly important role in domestic procedures as in ADR procedures the resolution-makers have expertise in the matter. In domestic litigation cases it is critical to the success of the procedure to identify the right expert witness who can explain to the court the complex issues arising in international taxation.
Kinsella: Expert witnesses are very significant for both transfer pricing and valuation cases. For purely tax technical cases, they may be less significant. The advantage of introducing an expert is that it allows opinion evidence to be admitted to the court in circumstances where it would otherwise be inadmissible, and it may be necessary to assist the taxpayer to meet the onus of proof. Sometimes, experts are required simply to challenge expert evidence put on by the other side. The disadvantages of introducing experts include cost and litigation risk – for example, have they been asked the right question, do they have the right expertise, how will they handle cross examination, and so on.
FW: What steps should companies take to establish a cross-border tax dispute management strategy – one that can effectively pre-empt a dispute and mitigate future exposure?
Gracia: The best strategy for companies to follow is to appoint a lawyer from the moment they are notified that a tax investigation process has commenced. This is the best time to provide data and facts to the file that can support consistency in the taxpayer’s position, and generally provide a better defence in the courts.
Kinsella: First and foremost, for companies to establish a cross-border tax dispute management strategy, they should consider the need for an independent and objective review of their tax risk and their evidence – the earlier this occurs the better. The ATO is currently championing the concept of ‘justified trust’ and conducting reviews of Australia’s top 1100 taxpayers. In those reviews, the ATO will look at a taxpayer’s tax governance framework, any significant and new transactions by the taxpayer, how the taxpayer manages tax risk that the ATO communicates to the market and whether there is a significant difference between the taxpayer’s accounting and tax results and if there is, the ATO will want an explanation of the reasons for that difference. There are also other processes available to taxpayers to minimise risk in relation to cross-border tax disputes, such as advance pricing agreements and obtaining private rulings from the ATO in advance of transactions being entered into.
Jeens: Companies should be prepared from the outset. That means considering how potential transactions or arrangements might be challenged in advance and ensuring relevant supporting evidence is preserved. It is much easier to explain the commercial rationale for a transaction if there are contemporary board minutes or papers to refer to. Another key theme is to be able to explain the matters in dispute to a wide range of stakeholders; even if the tax team understands the issues, the tax authorities, the courts or the media may not and are often unsympathetic. Taking a forward looking and holistic approach to cross-border tax issues helps mitigate the risk of disputes arising, the time and cost of resolving disputes and any collateral or reputational consequences of those disputes.
FW: What are your predictions for cross-border tax disputes in the years ahead? Are there any factors which may simplify or complicate matters?
Kinsella: There is currently significant activity by the ATO in relation to transfer pricing. The ATO was emboldened by its win in the Chevron transfer pricing case in 2017 and recently issued a practical compliance guideline to provide criteria to both inbound and outbound taxpayer groups in relation to the terms and conditions and pricing of cross-border debt. The ATO has also issued alerts in relation to marketing and procurement hubs established in offshore jurisdictions. Since 2013, the ATO has had the benefit of strengthened transfer pricing provisions in Australian tax law. Significant audit activity is currently being undertaken by the ATO and significant funds from the government have been allocated to the ATO for this activity. Recently the ATO has been issuing extensive information and document notices, which may give rise to disputation in the future at an interlocutory stage.
Jeens: Cross-border tax disputes will continue to bring significant challenges, both for tax authorities which remain under political pressure, often have ever increasing remits to accompany new powers and will have growing pools of data to work with, and for taxpayers, which will largely need to make the running on any dispute or settlement. Undoubtedly, a complicating factor going forward will be increased transparency between tax authorities and the risk of public scrutiny of any settlement. Resolving cross-border disputes on a lasting basis will mean compromise between different jurisdictions and proper legal and corporate communications advice, alongside technical tax input. Practically, that means the days of saying a transaction was fine in a particular jurisdiction because the tax advantage or saving was in another jurisdiction are over. And the attack on ‘double non-taxation’ in the BEPS project has been taken up in many jurisdictions as a way to challenge untaxed income or claims for credit or deductions. However, one positive factor in this is the increasing availability of technology tools to help identify and present the relevant data – for instance, using artificial intelligence (AI) to match accounting data with the more unstructured supporting evidence needed in a transfer pricing case.
Gracia: As a consequence of the OECD’s BEPS project and the new EU directives on anti-avoidance measures and the exchange of information and growing tax collection needs of the Tax Administration in Spain, cross-border tax disputes are expected to increase. However, the proliferation and improvement of ADR procedures must be considered a positive, provided that the Tax Administration is given the necessary human and material resources to face the avalanche of tax disputes that it will have to resolve. Otherwise, the procedures will be perpetuated and will negatively affect the technical quality of resolutions, as is currently the case in domestic procedures. An indirect benefit of the ADR procedures may also be that they can deter reassessments when the national law provides for settlement agreements. Otherwise, it can foster a positive outcome at the MAP stage between the competent tax authorities involved, to avoid reaching the arbitration phase.
Eduardo Gracia advises a wide range of Spanish and international corporates, funds and financial institutions on the tax planning and structuring of inbound investment into Spain relating to project finance, M&A, real estate and distressed asset deals. He has also advised on outbound investments advising on the corporate and operational restructuring of multinationals. He specialises in Spanish, EU and international taxation of companies, VAT and other indirect taxation, as well as tax dispute resolution matters. He can be contacted on +34 91 364 9854 or by email: email@example.com.
Chris Kinsella is a senior tax partner with MinterEllison and has over 30 years’ experience assisting clients with Australian tax advice and disputes. He focuses on assisting clients to resolve and, if necessary, litigate their tax disputes. Mr Kinsella is a solicitor and chartered accountant. He is accredited as a specialist in dispute resolution by the NSW Law Society. He can be contacted on +61 2 9921 8614 or by email: firstname.lastname@example.org.
Richard Jeens’ practice spans a broad-range of high profile disputes, investigations and contentious tax matters, often involving multiple jurisdictions. He is co-head of the tax disputes practice and has experience advising clients at all stages of a dispute, from how to avoid potential challenges through to eventual proceedings. He acts for major corporates, trustees and financial institutions, as well as governmental bodies and international organisations. He can be contacted on +44 (0)207 090 5281 or by email: email@example.com.
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