Editor: Valrie Chambers, Ph.D., CPA
Foreign Income & Taxpayers
In December 2011, the IRS announced its plans to implement a program, advanced by the Organisation for Economic Co-operation and Development’s (OECD’s) Forum on Tax Administration (FTA), to “jointly” audit multinational taxpayers with tax administrations from around the world, but always on the basis of a tax treaty between them. (All of the materials the OECD published on this subject are available at www.oecd.org, as a means of increasing its own transparency.)
The FTA is a body within the OECD and its Committee on Fiscal Affairs and is composed of the heads of tax administration bodies in 45 OECD member and observer nations. The FTA is a forum for tax administrators to discuss common problems and concerns, work together to improve tax administration, share information on challenges and solutions, and work more cooperatively to improve the effectiveness of overall tax administration. Joint audits present unique challenges and opportunities that are only briefly addressed in this item.
The program the IRS announced arises from a report released during the sixth meeting of the OECD Forum on Tax Administration in September 2010 in Istanbul, Turkey. The Joint Audit Report introduced the program by saying;
As a consequence of today’s increasingly borderless world and the growth in international transactions by entities (corporations, trusts and other enterprises) and individuals, revenue bodies need to plan for the challenges of a vastly increasing number of taxpayers with international issues. This increasing internationalisation will also mean revenue bodies will need to cooperate and collaborate more closely in order to optimise compliance with international and national tax rules.
The concept of a “joint audit” is relatively simple, but applying it in practice is a significant challenge for revenue bodies and taxpayers alike.
Example: Tax treaty partners in countries A and B have an interest in the proper income tax reporting of multinational entity Z, which operates in their national borders. The idea is that A and B, operating under the Exchange of Information (EOI) article in their bilateral tax treaty, could work as one team (rather than conducting two separate examinations) to examine Z’s accounts.
In theory, all requests for information from Z would be issued simultaneously by A and B, following their own domestic rules and procedures, and then analyzed and discussed by the revenue bodies under the provisions of the Information Exchange article in their bilateral tax treaty.
One or more members of each of the country teams would have delegated competent authority privileges to ensure strict compliance with the terms of the bilateral tax treaty to guard against unauthorized disclosures or unauthorized sharing of information. In theory, the joint analysis would balance the respective interests of the two countries and avoid misunderstandings about the application of domestic law to the facts presented by the taxpayer.
As the joint audit proceeds, the domestic law, rules, and procedures of each country would be observed, including, if adjustments resulted in additional tax, administrative appeals and judicial remedies. One possible outcome of a joint audit with transfer-pricing implications is that as the examination progresses, the respective competent authorities of the two governments could be discussing proposed adjustments and may have the ability to resolve these differences through a procedure similar to a mutual agreement proceeding (MAP) if the governments and the taxpayer can agree on the process. Assuming a successful outcome in this approach, the usually lengthy MAP time frames could be significantly reduced, resulting in certainty much sooner than currently.
However, the joint audit is itself much more valuable than just its potential MAP time savings, and it is unlike the usual information exchange. A joint audit is often incorrectly compared to a simultaneous information exchange. In this type of an exchange, an examiner identifies information that he or she believes would be valuable to another revenue body and shares it, through the competent authority, with the other revenue body. Similarly, an examiner who believes another revenue body may have information, or access to information, that he or she believes would improve the examination, may request, through the competent authority, that the other revenue body share the information.
In the joint audit, the two revenue bodies jointly develop an audit plan (with input from the taxpayer) containing the issues to be addressed, timelines, and milestones. A few of the issues suitable for consideration in a joint audit, according to the Joint Audit Report, are transfer pricing, residency and permanent establishment determinations, structures and aggressive planning schemes, restructurings, cost-allocation agreements, hybrid instruments, and value-added-tax fraud.
Taxpayers are invited to participate in a joint audit. Taxpayers may prefer to achieve greater certainty sooner than in a traditional examination process, but it is still the role of the tax administrator to decide who, when, and how a taxpayer will be examined. However, given the growth of cross-border business activities and the ever-present concerns about the proper allocation of profits and losses, the joint audit appeals to administrators as a means to achieve their own certainty and a lower-cost examination process. So, when tax administrators conclude that they have mutual interest in a multinational enterprise’s tax reports, and the time, resource savings, and potential outcome are mutually beneficial, they may discuss using a joint audit.
Tax administrators must also consider a few limiting factors that could make the joint audit process more challenging. For one, the domestic laws of the two countries could be different, as might their administrative and judicial processes, making it very difficult to resolve issues. Cultural and language differences also can make ongoing and free communication difficult. Furthermore, because the joint audit program is in the early stages of development, the earliest joint audits will likely encounter unforeseen hurdles and require a fair amount of high-level oversight.
Taxpayers that are approached by a revenue body about a joint audit should carefully evaluate their relationships with the tax bodies. How cooperative have these revenue bodies been with one another? How communicative have the revenue bodies been in the past, and how cooperative have the taxpayers themselves been in answering questions from the revenue bodies? They should further consider whether, in the past, all sides have been able to reach agreement on procedures and issues, and what the costs of managing two large examinations, with perhaps the same in-house resources being dedicated to the examination, might be.
Anecdotally, a few joint audits are already underway, but because of strict Sec. 6103 compliance issues (prohibiting disclosure of tax return information), unless a taxpayer consents to a public discussion, or discusses it in a public filing, little will likely be heard about these examinations.
The FTA members are publicly committed to cooperation in these efforts and to greater coordination, but the FTA has only just begun the joint audit process. It will take time to know whether the process bears the fruit the OECD imagines.
From Barry Shott, New York City
Valrie Chambers is a professor of accounting at Texas A&M University–Corpus Christi in Corpus Christi, Texas. Barry Shott is a senior managing director with PwC’s Advanced Pricing & Mutual Agreement (APMA) and Transfer Pricing Controversy Services. Mr. Shott is a member of the AICPA IRS Practice & Procedures Committee. For more information about this column, contact Prof. Chambers at email@example.com.