Have you found the policing of cross border transactions within an international group to be a target of the tax authorities’ attention and in what ways?
Tax (3rd edition)
Lately, cross-border transactions within international groups of companies have come under increasing scrutiny from the tax authorities. Transfer prices between related entities are thoroughly assessed to make sure that they are consistent with the arm’s length principle. Offshore entities are closely inspected as well, and may be considered a Swiss resident if their effective place of management is in Switzerland (see 7 above).
The IRS has devoted significant resources within LB&I to policing cross-border transactions, and following the TCJA, will be expected to continue to do so.
One area of significant focus within the IRS has been transfer pricing, particularly of licenses and transactions involving intangible property involving low-taxed foreign affiliates of US corporations. In recent years, the IRS has litigated transfer pricing cases involving hundreds of millions or billions of dollars of transfer pricing adjustments against Amazon, Medtronic, and Coca-Cola, among others. As part of Tax Reform, changes have been made to the transfer pricing statute, Code Section 482, to attempt to codify certain of the IRS’s litigation positions.
Another major focus of the IRS has been on cross-border reorganizations and “inversion transactions.” For example, in July 2018 (TD 9834), the IRS and Treasury finalized a comprehensive and controversial set of regulations under Section 7874 to limit the ability of US parent companies to “invert” under foreign ownership in certain cross-border mergers and combinations. The Section 7874 regulations greatly expand the reach of the inversion rules and the consequences of having been subject to an inversion. These rules need to be carefully considered in any transaction in which a US corporation is reorganized under a foreign corporation.
The IRS and Treasury have aggressively challenged transactions perceived to result in the tax-free repatriation of foreign earnings by US multinationals. Most recently, this includes IRS Notice 2016-73, addressing tax-free repatriation via so-called “Killer B” transactions. In another example, in Illinois Tool Works Co. v. Commissioner, TC Memo. 2018-121, the Tax Court recently rejected the IRS’s challenge to use of intercompany lending by a US parented group to effect a tax-efficient repatriation of earnings. With the TCJA’s repeal of deferral and new worldwide tax on foreign profits as GILTI, it can be expected that cash repatriation strategies will be less of a focus of taxpayers or the IRS in future periods.
In the context of foreign-owned US groups, another major focus of the IRS has been on intercompany debt and interest deductibility. Historically, the IRS has challenged such interest stripping using common law debt-equity principles to assert that purported debt was, in fact, an equity contribution. Recently, final regulations under Section 385 also apply to treat debt owed by a US corporation to a foreign affiliate as equity where it is created in certain debt pushdown transactions that do not result in new investment into the United States. The Section 385 regulations are under review by the Trump administration and may be repealed or modified. In addition, TCJA has amended Section 163(j) to provide a thin capitalization test to all interest expense of US corporations, whether on intercompany debt or third party debt (see Question 9 below).
The CRA has over the last 15 years devoted significantly greater internal resources to transfer pricing audits, which are initiated virtually as a matter of course when the CRA becomes aware of non-arm’s length transactions involving non-residents. The CRA is increasingly aggressive in challenging intercompany transactions, with a particular focus on inbound and outbound royalty payments and inventory transfers, transfers of technology to low-tax jurisdictions, and the payment of management and guarantee fees by Canadian taxpayers. Transfer pricing penalties assessed by the CRA have increased dramatically in the last 5 years.
In 2016 Canada became a signatory to the Multilateral Competent Authority Agreement to implement the OECD’s transfer-pricing documentation requirements and country-by-country reporting. Consistent with the OECD recommendations, the Income Tax Act now requires country-by-country reporting for multinational enterprises with annual revenues exceeding €750 million in the preceding taxation year.
Ordinary tax audits usually encompass VAT, CIT and withholding taxes. In case of ordinary tax audits, cross-border transactions within international groups always play an important role for tax authorities. Usually, increased attention is devoted to re-organizations, transfer pricing issues and other transactional details, such as debt-push down structures.
There are separate tax audits on wage tax and social security contributions and on stamp duty issues.
When a company is facing a tax audit, the tax agent is immediately requesting the local file relating to the transfer pricing (TP) policy of the group and the annual tax forms 2257 relating to TP, as well as any ruling granted by the FTA. However, no significant increase in TP's tax reassessments has been noted yet: the FTA agents still tend to ground these tax reassessments on the theory of the abnormal management act, rather than on specific TP provisions.
This situation may change in a near future when the FTA will exploit the recent TP data collected from the taxpayers as well as the data collected via the new Country by Country Reporting filed for the first time in 2017.
Most companies in Cyprus operate internationally and the tax authorities do not target such companies.
Cross border transactions are not the main focus of the Brazilian tax authorities. Notwithstanding, when performing an audit, tax authorities will pay attention on the company’s cross border transactions (remittances of dividends, royalties, service fees, among others) and its compliance to the transfer pricing rules. Also, they will pay special attention on Brazilian multinationals with offshore business.
Cross-border transactions within an international group of companies are a main focus during tax audits exercised by the tax authorities in Germany. In particular, transfer prices and the related documentation are often challenged by the tax authorities. If the documentation requirements are not met, the tax authorities are in principle authorized to estimate the respective prices which in almost all cases will lead to a higher tax liability.
For many years Ireland has been an important location for international groups. Therefore cross border transactions have long since been the focus of tax authorities’ attention. The key areas of attention in cross border situations typically involve (a) assessing the substance and activity in Ireland to determine applicability of the 12.5% tax rate on trading income; (b) reviewing base-eroding interest payments out of Ireland; (c) consideration of deductibility and arm’s length nature of royalty and other payments to foreign jurisdictions, particularly non-DTA partner jurisdictions;
Irish Revenue have also played a significant role over the years in defending the Irish tax base from permanent establishment and transfer pricing assessments by foreign taxing authorities.
Yes. One of the fields the ITA has been focusing on in cross-border transactions relates to group restructurings and implementation of changes to business models, most commonly following an acquisition of an Israeli target company. The ITA will typically examine whether such restructurings, the impact of which may reduce taxable profits in Israel, have a business purpose and legitimate and economic substance beside the main purpose of tax avoidance. A particular area of focus is the appropriate transfer price of intellectual property of newly acquired Israeli companies that is transferred to its non-Israeli affiliates post-acquisition.
In addition, the ITA tends to carefully examine claims for reduced rates of withholding based on double tax treaties and is sensitive to treaty shopping. Prior to determining eligibility for treaty benefits with respect to related party cross-border transactions (such as reduced rates on royalty or interest payments), the ITA will check if the entity claiming relief is resident both “legally and factually” in the treaty country and the is the beneficial owner of the income. In conducting the examination, the ITA applies general beneficial ownership and “economic substance” doctrines.
Yes, there has been an increase in transfer pricing audits conducted by the IRB, especially where there is great volume of related-party transactions and inconsistent profit margins. IRB’s special focus seems to be on intra-group services and purchases.
Yes, Mexican tax authorities pay close attention to cross border transactions in order to avoid base erosion practices and the inappropriate application of tax treaty benefits. In fact, a special unit within the SAT is in charge of reviewing these operations and is frequently pursuing the compliance of regulations enacted to avoid these practices.
As of recent years, the Mexican Income Tax Law and other regulations suffered different reforms to adapt policies that are compatible with the BEPS Action plans. For instance, interest, royalty or technical assistance payments made by Mexican entities to foreign related parties controlled by the taxpayer shall now be considered as deductible only to the extent that (i) they are not made to a transparent entity, the owners of which are not subject to tax in their residence jurisdiction, (ii) the country of residence of the recipient considers such payments as taxable income in the hands of the recipient; or (iii) the payment is considered to exist for purposes of the jurisdiction in which the recipient is a resident of.
In pursue of assuring the compliance of rules of the kind, Mexican tax authorities are considerably active and have implemented not only regulations that will facilitate the vigilance of base erosion practices, but also impose mandatory information returns and other reports that allow them to identify these transactions and verify whether any irregularities exist.
The Norwegian tax authorities have a particular focus on transfer pricing issues in relation to cross border intra-group transactions, i.a. in relation to intra-group financing, provision of services and cross-border re-organisations. Further, there has been a focus in recent years on transfer pricing in the petroleum sector, i.a. in relation to the pricing of gas sales from the Norwegian continental shelf.
Cross border transactions are targets by the tax authorities as usually involves multinational companies and taxpayers under the category of big contributors. Taxpayer under this category are more exposed to tax audits by the authorities.
In cross border transactions tax authority review if the capital gain tax rules had been applied in addition that stamp taxes had been covered.
Except for transfer pricing issues, the regulation and monitoring of cross-border transactions within an international group is not currently a target of the Philippine tax authorities. It may even be said that the tax authorities have somehow relaxed the monitoring of cross-border transactions. An example of this is the recent decision of the tax authorities to dispense with the requirement of securing a tax treaty relief ruling to claim exemption or preferential treaty rates on royalties, interests and dividends received from the Philippines. As a result, tax treaty benefit for these types of income may be claimed outright. As it stands now, if royalty, interest or dividend income has to be paid, the withholding agent just has to report the tax treaty availment using a prescribed tax form within thirty (30) days from payment of the applicable withholding taxes.
Cross border transactions within an international group are one of the targets of the tax authorities, which focuses on transfer pricing issues, withholding tax (dividends, interest – e,g. under cash pooling agreements or otherwise - royalties), payments to low tax jurisdictions, etc.
Italian tax authorities tend to have a strict approach and are also usually keen on verifying cross-border transactions of companies of multinational groups. Particularly, the challenges most often raised by the tax authorities are the following:
- Assessment of tax residence of foreign holding companies. In these cases, the tax authorities challenge the residence status of the foreign entity claiming that, on the basis of an analysis of all facts and circumstances, it shall be considered tax resident of Italy because its main object or place of management (see answer No. 7 above) are to be located in Italy.
- Existence of an Italian permanent establishment. In these cases, the tax authorities claim that the Italian operations of the foreign company determine the existence of an Italian permanent establishment and tax them accordingly.
- Transfer pricing.
- Denial of the treaty WHT rates due to lack of beneficial ownership condition and denial of dividend WHT exemption in case of abuse of the European Directives.
In Turkey, tax authorities tend to audit the activities of international group companies in Turkey. Most of the audits focus on intra-group payments.
On the other hand, PE audits started to take a brand new dimension in Turkey and many of worldwide companies are one by one taken under tax audits based on permanent establishment claims in line with a new approach of tax authority.
Yes. Cross border transactions within an international group have been one of the most important focus in the enforcement of Japanese tax law. Typically, pricing or profit allocation as to intra-group transactions is scrutinized based on Japanese transfer pricing regulations. Also, cross-border intra-group transactions are frequently scrutinized in terms of Japanese withholding tax (i.e., if there is any failure to withhold applicable withholding tax), consumption taxes (i.e., if there is any failure to report input tax by the foreign affiliate even if it has no PE in Japan) or thin-capitalization and earnings-striping rules (i.e., if the Japanese affiliate takes interest deduction in excess of these regulations). Moreover, cross-border reorganization or recapitalization transactions was a significant focus of the enforcement, as seen in certain two Japanese tax tribunal and court cases (the IBM case and the Universal Music case), where the Japanese tax authority tried to disallow the tax consequences achieved by the parties that were consistent with the individual provisions of Japanese tax law, by invoking certain general anti-avoidance statute applicable to closely-held corporations.
The policing of cross border transactions within an international group are not specifically the target of the Dutch tax authorities’ (DTA) attention.
However, transactions (supply of goods, services, financing, guarantees, etc.) between related parties have to take place under the same conditions as transactions that would have applied in the market between independent parties, i.e. the at arm’s length standard. In this respect a question needs to be answered in the annual Dutch corporate income tax return to be filed. The DTA regularly checks whether this at arm’s length requirement has been met.
TP aspects related to pricing of related party transactions (including cross-border transactions within a multinational group) represent one of the key focus areas in tax audits conducted by Romanian tax authorities. TP documentation prepared in accordance with specific Romanian TP documentation requirements is expected to be already available (for certain taxpayers) or provided within certain deadlines specified by the regulations. Scrutiny of the tax authorities is related not only to the content of the TP documentation but also in relation to substance of the related party transactions (e.g., we have observed challenges of the functional and risk profile of the entities, challenges in terms of compliance with specific Romanian TP requirements of the benchmarking analyses). The number of TP adjustments resulting from audits concluded by the Romanian tax authorities has increased significantly in the last period.
There are relevant provisions applying to cross border transactions in European and international legislation and regulations that must be adhered to when dealing with international structures. These are applicable to Gibraltar. Tax authorities may pay particular attention to cross border arrangements, however generally, provided that the relevant rules and legislation are observed in each applicable jurisdiction, there should be no issues.
International tax planning and avoidance has a high public profile in the UK. The UK has been an active and vocal supporter of the OECD and BEPS project since its inception and has actively implemented BEPS recommendations. The UK was ahead of the BEPs process with the introduction, in 2015, of the Diverted Profits Tax, to claw back any profits that have been shifted to avoid tax. Furthermore, the UK had the arbitrage legislation since about 2005. So attention has been paid to cross-border transactions for a long time.