In 1972, Richard Nixon made an historic visit to China and deftly exploited the rivalry between that country and the Soviet Union to the ultimate advantage of the United States. Did he provide a lesson for CFOs?
While getting in touch with your inner Nixon may sound like curious advice, when it comes to global tax headaches it just might work. Specifically, it can be a way to survive a revenue row when your company is under scrutiny by the tax authorities of two different countries.
“If CFOs and tax managers can get two tax authorities in the same room at the same time, and put all the issues and treaty provisions on the table,” says Rich Walton, a tax-controversy specialist at law firm Buchalter Nemer, “they can play one agency off against the other.” That approach, he says, is far better than “fighting the issues piecemeal.”
Such foreign diplomacy is likely to come in handy over the next few years as the Internal Revenue Service and its counterparts in other countries ramp up their use of so-called simultaneous audits, a loose term coined by tax professionals to describe two separate exams, conducted by different governments, in which those governments share with each other some of the taxpayer’s information. At first glance, the prospect of governments teaming up on global tax investigations may seem like a nightmare, but such cross-border efforts offer some unexpected opportunities.
Although they’ve existed since the 1970s, simultaneous audits are increasingly common today as government tax agencies race to match the level of global coordination practiced by multinational companies and their tax advisers. Like the proverbial blind men trying to describe an elephant, “governments have a skewed perspective of a transaction if they rely only on domestic sources of information,” says Rocco Femia, a tax attorney with Miller & Chevalier.
More Scrutiny Ahead
The rules for exchanging taxpayer information with other countries are governed by treaties that, mercifully, contain substantial controls on such practices. The United States has treaties with about 60 trading-partner countries that include information-exchange provisions; those provisions are often used to assess transfer-pricing practices (by far the most common reason for countries exchanging corporate tax information) or uncertain tax positions. The United States is also pushing for more collaboration with other countries through such groups as the Joint International Tax Shelter Information Center (JITSIC), a Washington, D.C.-based global effort that targets abusive international tax-evasion schemes.
Two Birds with One Audit
At any given time, a company with “a big global footprint” — one that does business in 100 countries or more — could be juggling as many as 40 single-country audits, says Debbie Nolan, a member of Ernst & Young’s national tax practice, and former IRS commissioner for the agency’s Large and Mid-Size Business Division. Combine that audit load with U.S. state tax examinations and “companies are really challenged to manage global tax risk.”
That’s the main reason a company actually may want two countries to team up to examine its cross-border transactions. The double effort can boost audit efficiencies and save time and money. Simultaneous exams and joint audits help companies avoid “reinventing the wheel” every time a new audit begins, says Todd Simmens, partner and national director of the tax controversy and procedure practice at BDO.
Even more important than efficiency, however, is that cross-border cooperation can help a company avoid being taxed twice for the same revenue. That often happens when countries disagree about a company’s application of transfer-pricing guidelines. Multinationals regularly allocate revenue among their business units, usually moving income to lower tax jurisdictions when allowed by law. Such movement is bound by country-specific transfer-pricing laws — such as Section 482 of the U.S. tax code — as well as international guidelines from the Organization for Economic Cooperation and Development. But if tax authorities in one country believe a company has ignored the economic reality of a transaction and is “artificially” shifting income to another country only to reduce its tax bill, then both countries may claim the right to tax that income.
In such cases, the countries themselves may use simultaneous audits to exchange taxpayer information and work out a proper allocation. But companies seeking to fend off double taxation can also initiate that process by requesting “competent authority assistance.” At that point, the company is likely to become a “bystander” in the process, says Femia.
In most cases, he explains, the countries negotiate a settlement and the case never has to go to arbitration. Further, with all the tax issues out on the table, and each jurisdiction jockeying for its slice of the revenue pie, corporations can wind up paying a lower global effective tax rate, especially if the lower-tax jurisdiction wins more of the revenue allocation, notes Buchalter Nemer’s Walton.
Enforcement Versus Service
Often the biggest downside to an unplanned simultaneous audit is the discovery that a corporation’s different units have inconsistent tax policies, an embarrassing and painful symptom of poor internal controls or procedures. The growing threat of simultaneous audits — or even the judicious solicitation of them — can prompt firms to tackle that sooner rather than later.
Nolan also says that firms would do well to understand the difference between the collaborative modes — enforcement and service — in which tax authorities operate. In enforcement mode, tax agents from different countries collaborate on a joint risk assessment to identify companies that appear to be high risk with respect to audits. That is often the case with JITSIC members when they target dodgy tax-shelter transactions.
“Large multinationals rarely engage in outright tax evasion — the downside is too great. But their tax planning is still routinely challenged during audits,” Walton says.
Those companies are better off proactively vetting that planning with tax authorities who are in “service” mode. “Companies could take action that enables tax administrators to become more efficient and, in exchange, the tax administrators could agree to be very focused and engaged in a well-organized resolution process,” says Nolan. That includes the creation of advance-pricing agreements that proactively answer a corporation’s income-allocation questions.
In fact, as international tax scrutiny increases, the winners may outnumber the losers. Not only will the countries involved likely fare better by cooperating, but companies willing to be transparent may find their strengthened relationships with tax authorities result in speedier judgments about their tax positions.
Marie Leone is senior editor for accounting at CFO.