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 (4th edition)
Given the conceptual reach of the definition of residence of a legal entity, we have observed very few assessments and inquiries on the matter and that these are incipient, mainly if we consider the growing cross-border structure of large conglomerates. However, even if slowly, we observe a growing dedication to cross-border matters on the part of the tax authorities, such as the recent auditing initiative on transfer pricing control relating to intangibles.
The Canada Revenue Agency is increasingly active in international tax audits. The Government of Canada has publicly announced that it would continue to support the Canada Revenue Agency’s efforts by allocating additional funds for hiring new international tax teams. Transactions and investments made by Canadian individuals, corporations and trusts in low-tax jurisdictions are being targeted by the international tax teams. Once identified, taxpayers with offshore investments are typically called upon to answer a quite invasive questionnaire in which they will have to disclose all of their foreign transactions. A follow-up face-to-face interview is also frequently conducted by the tax auditors. The taxpayer can be assisted by a lawyer during the interview.
Most companies in Cyprus operate internationally and the tax authorities do not target such companies.
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.
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.
In the past, areas in which tax authorities traditionally focused were among others the deductibility of management fees and other cross border intra-group payments as well as withholding tax in respect of cross-border payments challenged as being royalties. Mostly since January 2014, when the currently applicable Income Tax Code (ITC) and Code of Tax Procedure (CTP) came into force, transfer pricing has become an area of primary focus for the tax authorities. Disputes have shifted towards matters concerning the reliability of comparable data, the reasonableness of comparability adjustments and lately the appropriateness of selected transfer pricing methods.
Also, in the past, in the absence of domestic anti-abuse provisions, tax avoidance was not targeted by Greek tax authorities in a tax audit. This is anticipated to change, as Greece has relatively recently enacted a number of rules that aim to effectively combat artificial arrangements aiming at tax avoidance.
Yes, cross-border transactions such as determination of a foreign entity that has a taxable presence in India (akin to a Permanent Establishment in India) and related party transactions subject to the transfer pricing regulations, have been the focus of the tax authorities. For the cross border related party transactions, a taxpayer has to undertake a transfer pricing benchmarking analysis to determine arm’s length price (“ALP”) in accordance with the prescribed method and to file a transfer pricing report.
Recently, as a measure to prevent BEPS, India has introduced additional group reporting requirements in the form of Country by Country reporting and Master file reporting for entities crossing the specified threshold, to report the intra-group transactions in greater detail.
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 recently published a comprehensive circular number 15/2018 (the "Circular"), addressing the Israeli income tax aspects of business model restructuring by multinational groups. A change of a business model refers mainly to circumstances under which functions, assets or risks (so called "FAR") of an entity are transferred or terminated. This matter is commonly raised in tax audits of Israeli companies that are acquired by multinational groups, and following the closing of the acquisition, the intellectual property of the Israeli acquired company is transferred, or deemed transferred, to a non-Israeli affiliate, or the entrepreneurial aspects of the acquired company (such as sales functions) are terminated. The Circular addresses two major aspects of a business model change: (a) the identification and characterisation of such change in the business model; and (b) valuation concepts and methodologies of the FAR transferred in the course of such business model change. The Circular states that it follows the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations from 2017 (the “OECD Guidelines”). We should note that the Circular represents the ITA's interpretation of the law and accordingly, its position on said matters. The Circular does not, however, have any legal binding status and therefore, courts are not bound by it.
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.
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.
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 reorganizations, 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.
Cross-border transactions within an international group have been one of the most important targets under Japanese tax laws in recent times. In particular, after the introduction of documentation on transfer pricing, areas such as intra group services and lending and borrowing among international groups have been highly focused on during tax audits.
The Luxembourg tax authorities pay attention to cross border transactions between related parties, especially on intragroup financing activities.
Since the issuance of the Circular n° 56/1-56bis/1 and the renewal of the LITL, mentioning the basic principles to be followed in conducting a transfer pricing analysis (please refer to question 9 for more details), the Luxembourg tax authorities are keen on reviewing intragroup financing activities and whether they are secured with a transfer pricing study to prove its arm´s length character.
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. The IRB’s special focus seems to be on intra-group services and purchases.
In line with the BEPS Action Plan, Mexican tax authorities are particularly concerned with base-eroding practises. Consequently, in the case of cross border transactions, they tend to focus on transactions between related parties, corporate reorganisations and similar operations conducted by multinationals.
To this regard, tax audits with respect to such operations tend to focus on the adequate compliance with transfer pricing rules (arm’s-length transactions), the (non)deductibility of certain expenses, or the actual existence of double taxation when the parties involved claim treaty benefits. For instance, parties that claim treaty benefits are required to comply with certain formal tax obligations under Mexican law in order to evidence that they actually qualify as residents in terms of the corresponding double taxation agreement and as such, that they are in fact entitled to the relevant tax benefits.
Moreover, concerning transactions between related parties in which treaty benefits are claimed, Mexican tax authorities could request a sworn affidavit (executed by the foreign resident’s legal representative) stating the existence of double taxation and identifying the statutes or provisions under foreign law that cause it.
Furthermore, taxpayers in Mexico are bound to file informative returns in relation to their transactions with related parties or concerning their participation in offshore structures (they are subject to country-by-country and other returns based on CRS), pursuant article 76-A of the Federal Tax Code. The Supreme Court has settled jurisprudence on the constitutionality of such measures.
The Dutch tax authorities do not specifically police cross-border transactions within an international group.
Transactions between associated enterprises must, however, take place on an at arm's length basis. In the Dutch corporate income tax returns, questions on intercompany transactions must be answered by taxpayers, furthermore, documentation substantiating the arm's length nature of intercompany transactions must be kept in the taxpayer's administration.
The Dutch government does intend to propose a conditional withholding tax on interest and royalty payments made to low tax jurisdictions or in certain abusive situations. Current expectations are that the tax would apply as of January 1, 2021 and would be levied at a rate of 20.5% (the upper bracket corporate income tax rate).
Yes. In fact, our law provides different measures intended to tackle base erosion caused by the carrying out of cross border transactions either inside or outside a group of companies.
In that respect, in 2019 became effective a rule which conditions the deduction of expenses relating to royalties, interests and any retribution for services to non-residents upon their effective payment. Also, payments to foreign beneficiaries regarded as Peruvian source income are levied at rates ranging between 15% to 30%, with some few exceptions. Payments for services to residents in countries or territories of low or null taxation, or of non-cooperative jurisdictions, or payments through any of those jurisdictions are generally non-deductible, except for payments for (i) interests, (ii) insurance and reinsurance, (iii) lease of vessels and aircrafts, (iv) transport and (v) fees for the use of the Panama Canal.
In addition to these rules, SUNAT has enacted a series of regulations aligned with Action 13 of BEPS, aiming at the obtention of information on transactions carried out within group of companies. In that sense, taxpayers may, in accordance with their level of revenues, be obliged to submit informative returns such as the local report, the master file and the country-by-country report.
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.
Cross border transactions within an international group are one of the targets of the tax authorities, which focuses on: transfer pricing issues, assessment of tax residence of foreign holding companies, existence of a Polish permanent establishment, withholding tax (dividends, interest, royalties), etc.
Yes. In the context of the implementation of the BEPS, the approach of the Tax Authorities on cross-border transactions occurs mainly in the areas of transfer pricing, aggressive tax planning and Country-by-Country reporting.
Yes, there has been an increase in the policing of cross border transactions by SARS. The main issues in particular are permanent establishment challenges, transfer pricing and controlled foreign company based disputes.
The Spanish Tax Agency has recently devoted significant resources within to policing cross-border transactions.
Three areas have focused Tax Agency efforts when policing cross-border operations:
- Financial interest from inter-company debts.
- Permanent Establishment
- Transfer Pricing.
I. Financial Interest from inter-company debts
Before 2012 Tax Agency challenged excessive debts by means of the General Anti-abuse Rule considering that inter-company debts lacked of business reasons were mainly tax driven. After 2012 the Corporate Income Tax Law was amended introducing two main limitations to financial cost deductibility:
- Firstly, as a general anti-avoidance rule, interests paid to a group entity incurred in order to acquire shares or increase equity interests in other group members is wholly non-deductible (tainted financial expenses), unless the operation might pass a test business purpose.
- Secondly, remaining net finance cost (this is the net amount of financial income and cost, excluding the above mentioned tainted financial expenses) is deductible up to an amount equal to 30% of the operating profit defined as the accounting operating profit eliminating the effect of (usually increasing):
a The amortization of fixed assets;
b The subsidies for non-financial fixed assets and others; and
c The depreciation for impairment of fixed assets as well as the gains or losses derived from the transfer of fixed assets.
The resulting amount should be increased with dividends derived from entities when the stake (i) represents at least 5% of their share capital; or, alternatively (ii) has an acquisition cost exceeding EUR 20 million. This rule will not apply to dividends from subsidiaries which have been acquired from other companies of the group with group debts generating tainted non-deductible financial expenses referred above.
Net financial cost above 30% of operating profit could be carried forward and deducted in the following tax years (with no term limitation) within the same limit of 30% of the annual operating profit.
Conversely, if net financial cost is below 30% of operating profit (e.g. capacity excess) that excess of capacity may be carried forward to deduct more financial cost in the following 5 years.
The above limitations do not apply when:
- Net financial cost does not exceed EUR 1 million;
- The entities are incorporated under the legal from of insurance or financial entities; and
- In case of entities belonging to a tax unit or tax consolidation group, all the above calculations (net financial cost, operating profit, etc.) would be referred to the whole group.
II. Permanent establishment (PE)
Spanish Tax Authorities has developed an aggressive doctrine towards existence of Permanent Establishment that has been adopted by Spanish Courts and, at least partially, also by the OECD. This is the so called “Spanish approach to PE” that considers that foreign companies may be deemed to have a PE when by a “complex operating settlement”, this is the combination of a network of outsourcing agreements and resources they are actually carrying a business in Spain.
This doctrine has been successfully taken by the Supreme Court in Dell case and by the National Court in the ruling of 11 October 2018 that follows an argumentative line which is broadly similar to the Ruling of the Supreme Court in the Dell case (STS 20 June 2016; recourse no.: 2555/2015) as well as some rulings from Ministry of Treasury.
In this type of situation, the non-resident entity has a subsidiary entity in Spain that after a change of business model is suddenly reconfigured as a company with very few and limited risks that appears to be limited to providing sales support services, significantly decreasing its profits and the associated Spanish tax; such sales are made directly by the non-resident entity allegedly without a permanent establishment and, therefore, no taxation in Spain under the treaty and its Article 7. The affiliated company, before trading company, in the performance of its new functions does not have significant changes in structure or dimension.
After an in-depth analysis about the functional deployment of the multinational group in Spain, and as a result of the information usually got from customers, tax authorities concluded that the non-resident entity operates in Spain with permanent establishment, so called “complex operating settlement” this is a substantial operating conglomerate, a framework that is implanted and stable in Spain what is the same as a fixed business place.
One element that was crucial for the Tax Authorities challenge is that after the change of business model the Spanish subsidiary headcount did not change significantly, additionally, Spanish Inspection stated that in the periods in question the non-resident entity used the means (staff and facilities) of the related Spanish company to develop the distribution activity in Spain in all its phases. Moreover, it was noted that apart from the existence of property assets (facilities and personnel) owned by the subsidiary that were used for the benefit of the economic activity performed by the Non-resident entity in Spain.
In summary, the rulings rests on the fact that by its staff and facilities the related Spanish subsidiary deployed a wide range of functions and tasks in favour of the Non-resident entity, more so than just preparation or ancillaries, so it may be said that in such periods the Non-resident entity operated in Spain through a permanent establishment.
III. Transfer Pricing
Transfer pricing is currently the main focus of litigations between taxpayers
The transfer pricing rules included in the Corporate Income Tax IT Act covers both companies and individuals. It must be noted that Spanish legislation does not recognize the existence of trusts in Spain. In this regard, transfer pricing rules apply to CIT, Personal Income Tax and Non-Resident Tax.
Additionally, and in line with the Spanish Accounting Principles, CIT Act clearly specifies that controlled transactions carried out by related parties must be valued on an arm’s length basis. In this sense, the burden of proof falls upon the taxpayer who must provide documentation to proof to the tax authority that shows that the values applied in the transactions with related parties meet the principle of valuation at fair market value or on an arm’s length basis.
CIT Act establishes the obligation to make available to the tax authority the documentation that is determined by law. As explained below, this documentation obligation is divided on the basis of the concepts of “Country-by-country information”, “Specific documentation of the group” and “Specific documentation of the taxpayer”.
One significant point that makes different the Spanish Transfer Pricing regulations and give it more relevance is the broader perimeter of related or associated parties that obliges to apply transfer pricing principles and to prepare documentation to more operations that in other countries would not be regarded as related operations.
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 as Swiss residents 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, is 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.” 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.
For years in place prior to the TCJA, the IRS and Treasury also 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. The IRS has challenged and will be expected to continue to challenge such interest stripping using common law debt-equity principles to assert that purported debt was, in fact, an equity contribution. 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). As part of TCJA, Congress enacted new Code Section 59A imposing a base erosion minimum tax (“BEAT”) by reference to certain base erosion payments made by large US corporate taxpayers to foreign affiliates. Under the BEAT, certain related party payments of interest, royalties and other deductible amounts are added back in computing large US corporations’ taxable income. Following TCJA, the US has adopted comprehensive anti-hybrid legislation under Section 267A (see below).
Yes, the policing of cross border transactions within an international group has been a target of the tax authorities’ attention. This is seen through the introduction of Property Transfer Tax at share transfers which occur at international group level. The introduction of Transfer Pricing Regulations in the form of the Income Tax (Transfer Pricing) (Amendment) Regulations No. 24 of 2018.
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 the 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 has had the arbitrage legislation since about 2005. Accordingly, attention has been paid to cross-border transactions for a long time.
There are several factors indicating that the tax authority has increased its scrutiny of intragroup transactions. The number of tax inspectors specialized in transfer pricing has increased importantly, which has resulted in a higher number of transfer pricing audits. Also, new reporting requirements with regard to certain cross-border transactions have been introduced by law during the last several years. Most notably, Belgium has implemented into national law the transfer pricing documentation requirements in accordance with BEPS Action 13 (Law of 1 July 2016). These requirements will allow the tax authority to better monitor intragroup cross-border transactions.
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.