Global tax policy has evolved dramatically, with multinational corporations coming under attack from all directions. To respond to budget deficits and economic austerity, worldwide taxing authorities are deploying a new weapon: information exchange. As MNCs struggle to remain compliant and competitive in a world where effective tax rate management can be a critical element of cost control, what does this evolution mean for your business?
Opening the Kimono
Recent efforts to fight international tax avoidance and evasion have targeted MNCs, substantially increased the costs of compliance, and negatively affected customary tax planning. In 2010, for example, the U.S. Treasury and IRS enacted the Foreign Account Tax Compliance Act (FATCA) and entered into various reciprocal intergovernmental agreements (IGAs) with foreign partners. FACTA substantially expanded reporting requirements for financial institutions by requiring payments made to certain foreign entities to be documented. That was, for all intents and purposes, the beginning of the current era of worldwide information sharing.
MNCs have long sought to reduce their global tax burden by working within the tax rules of various countries for their benefit. Several U.S. corporations have mitigated their worldwide tax burden by “inverting” their corporate structure and relocating abroad.
Such tax base erosion, however, isn’t a uniquely domestic issue. Indeed, worldwide taxing authorities are concerned by the ease with which MNCs have been able to move operations, management, and intellectual property to lower their tax burden.
In response, the G-20 countries requested the Organization for Economic Cooperation and Development to increase communication among taxing authorities regarding MNCs. Over 100 countries are implementing the Base Erosion and Profit Shifting (BEPS) Action Plan to address base erosion and profit shifting.
One aspect of BEPS, for example, called country-by-country reporting (CBC), requires MNCs to provide information on where sales and profits are generated. These rules correlate economic activity with taxes paid on a country-by-country basis, ensuring that the proper amount of tax has been paid in each country. Countries like China, Japan, Italy, the United States, and the United Kingdom have passed BEPS legislation in 2016. On June 30, 2016, the IRS adopted CBC regulations that will become effective in 2017.
It’s fair to expect revenue-hungry countries to use the information as the basis for opening audits. Indeed, the OECD believes that BEPS will generate an additional $100-$240 billion in tax revenues for member countries.
The Road Ahead
Expect substantial changes in the way the IRS audits MNCs. The IRS is prioritizing international tax issues, and information exchange is the key to its new strategy. The IRS has replaced annual, continuous audits with issue-focused “campaigns.”
With fewer resources, the IRS is determined to engage with MNCs on issues that will bring in large tax revenue. To that end, IRS specialists have attended internal “boot camps” in preparation for a war on an ever-expanding list of topics detailed in published “International Practice Units.” CFOs can expect the IRS to take entrenched positions on these issues, making it harder to resolve examinations.
New rules are likely to complicate routine business operations. For example, the U.S. Treasury recently issued proposed regulations pursuant to Internal Code section 385, implicating all inter-company lending transactions.
Those regulations include complicated rules on cash pools and affiliate lending. They completely change the way multinational businesses move cash internally, impeding customary business practices. Failure to obey these new rules deems lending transactions to be equity transactions for U.S. tax purposes. That’s a very bad result for routine business transactions.
Increased reliance on anti-abuse rules is also a likelihood. Transactions that work technically may fail if the result was not the one intended by legislators. For example, the IRS will continue to assert the “substance over form” and “economic substance” doctrines to recast perceived abusive transactions. Many countries have similar provisions commonly referred to as “general anti-avoidance rules.”
Adapting to the New International Tax Paradigm
In meeting these new challenges, preparation is the key. Evaluate your international tax planning to identify areas that must change because of the shifting paradigm. Your tax rate strategy will necessarily change as the incidence of taxation will correlate more with the location of your business operations.
Ensure that your internal information systems (accounting, inventory, supply chain, etc.) are capable of creating the detailed reporting required. Multi-platform and antiquated systems must be evaluated and updated to handle the new information and reporting requirements. This will be especially challenging for entities built on the basis of aggressive acquisition and have left in their wake business units (and their systems) as stand-alone reporting entities.
Understand what information you will need to provide and which will be shared across borders. In this environment of hacking and data-mining, your detailed financial information may be used against you by competitors and governments or exploited for financial gain. Your system safeguards will be critical to protecting confidential information. Most companies (and countries) are ill-equipped to handle attack by well-trained hackers.
Create systems for documenting and substantiating your accounting and tax allocations. Consider the monumental task of organizing and storing all of the data a MNC collects as it engages in business. As your business comes under attack in new taxing jurisdictions, the ease by which you can produce information in response to inquiries will substantially reduce the strain on internal resources.
Business challenges abound, and the new era of financial and information disclosure will add to the complexity of doing business in multiple jurisdictions. The result will be substantially higher compliance costs and complications as a result of navigating different taxing systems.
MNCs will need to devote appropriate resources and time to satisfy reporting and documentation requirements. Nonetheless, new planning opportunities will emerge as countries begin to offer new incentives to attract business and new tax revenue. The picture may end up being more balanced than we think.
Kevin Spencer, a partner at McDermott Will & Emery, international law firm, focuses his practice on tax controversy and litigation issues. Cym Lowell, a senior counsel at McDermott, advises multinational companies on a broad spectrum of international tax planning and controversy matters. Denise Mudigere is a tax associate at McDermott.