Companies may soon experience new tax audits of several pandemic-related tax issues, according to the 2021 EY Tax Risk and Controversy Survey.
Whereas tax authorities played a pivotal role throughout the early stages of the pandemic, administering large swathes of fiscal stimulus and shifting tax filing deadlines to support businesses and individuals, governments are now facing increased pressure to raise revenue to cover new fiscal deficits.
Respondents expect higher enforcement will be coupled with higher tax burdens, with more than half forecasting a higher direct tax burden in the coming three years.
Although business welcomed 2020’s administrative relief, companies must now wrestle with several ongoing impacts on tax administration.
According to the survey, 48% of respondents say they generally experienced delays in their dealings with revenue authorities. These delays were more likely to have occurred in mature markets—in North America, for example, where the figure rises to 65%.
Just 28% of respondents reported a slowdown in incoming inquiries from tax authorities, confirming that much tax work continued as usual, although 35% did note a slowdown in tax audit and litigation activity. At the same time, there are signs that increased use of technology may have had a positive impact, with 26% reporting improved engagement with tax authorities due to the use of tools such as virtual meeting platforms. In Asia-Pacific, this figure was 38% and in Central and South America, 44%.
Tax Treatment of Pandemic-Related Issues
A plethora of tax challenges and disputes is expected as a result of the pandemic, with issues around worker mobility, pandemic-related losses, the claiming of tax refunds and even the receipt of stimulus measures identified as major concerns.
Tax issues related to personnel stranded overseas as a result of travel bans and immigration changes were the leading pressure point, highlighted by 45% of respondents. Both the Organization for Economic Cooperation and Development (OECD) and several countries have issued related guidance, and many nations have temporarily relaxed certain tax rules to try and mitigate the issue, which affects tax, social security and wider permanent establishment risks.
Differing tax treatment of pandemic-related tax issues—such as losses—is expected by 39% of respondents, rising to 48% in Asia-Pacific and 52% in Central and South America. This is not surprising, given 2020 changes to loss treatment, some temporary in nature, documented in at least 10 countries in the EY Tracker. While taxpayers may be keen to try and turn losses into deferred tax assets, opportunities to do so should be carefully assessed and managed from a tax risk perspective.
Other concerns voiced by respondents include the possibility of being tax audited as a result of receiving support or stimulus measures. In the U.K., for example, Her Majesty’s Revenue and Customs (HMRC) has estimated that somewhere between 1.75 billion British pounds ($2.46 billion) and 3.5 billion British pounds ($4.9 billion) could have been incorrectly or fraudulently claimed under its Coronavirus Job Retention Scheme. While HRMC has said that it will not pursue legitimate mistakes, multinational companies should consider making a systematic review of claims under all similar programs; 28% of survey respondents say they see potential for new tax audits in this area.
More than a third (35%) of respondents expect that cross-border businesses will see different transfer-pricing interpretations as a result of the pandemic. That concern led the OECD to issue new guidance, in late 2020, setting out clarifying comments on and illustrations of the practical application of the arm’s-length principle to the unique fact patterns and challenges arising during and after the pandemic.
In the enforcement area, increased scrutiny, while widely expected by respondents, is likely to vary by country. Geographic hotspots will continue to present challenges, while many tax administrations are likely to move ahead with new digital data submission requirements and broader transparency and disclosure laws. Italy, Mexico, Poland, and the U.K. have all seen new disclosure developments recently.
A number of countries are already known to be scrutinizing the largest multinational corporations (MNCs) more closely than before, looking for any tax uncertainties that may drive new tax audits and subsequent settlements. Several such countries have already announced tax settlements in the hundreds of millions, even billions of dollars. More countries may see that and follow suit.
New ‘Forensic’ Tax Audits and Documentation Requirements
Respondents’ concerns are based on real-world activity. In Japan, the resumption of audits in October featured fresh scrutiny of multinational companies’ cross-border transactions, as well as creating new requirements demanding near-forensic levels of supporting documentation.
Japan’s National Tax Authority also reports that transfer pricing adjustments have tripled in the last three years, from $2.2 to $6.6 billion. Japan is unlikely to be alone.
Indirect Taxes on the Rise
While VAT fell in many countries during first months of the pandemic—albeit temporarily in some and in a very targeted manner in most—the direction of change was not universal. In May 2020, for example, Saudi Arabia announced it would triple its VAT rate from 5% to 15%, in effect abandoning a long-term plan to introduce VAT at a low level and raise it gradually. Colombia, Oman, Qatar, and Ukraine similarly look set to have higher VAT rates in 2021.
Europe is also likely to experience a rising indirect tax burden in 2021, says Gjisbert Bulk, EY Global Indirect Tax Leader. “By eliminating reduced rates or exemptions, governments and authorities will broaden the base of VAT. They will also apply more scrutiny to what they’re seeing from taxpayers,” he says.
Actions to Take Now
Many MNCs confronted with the existing challenges of post-Covid-19 tax scrutiny; new forensic documentation requirements; and potentially major changes in international tax rules are considering whether there is a better way to manage tax controversy.
To prepare, many are investing in a broader, company-wide approach to tax risk and controversy management. The EY Tax Risk and Controversy Survey shows that 50% of companies use a Tax Control Framework (TCF), a model under which tax-risk management processes are embedded across all tax decision-making and certain corporate processes. Such companies tended to report better tax risk management outcomes than others. More than three quarters (76%) percent, for example, say they have either complete or substantial visibility over open tax audits globally—somewhat higher than the 65% for non-TCF users.
An effective TCF can be a useful starting point in developing the tax controversy department of the future, a framework approach in which all tax controversy is managed in three distinct solutions: risk assessment, risk management, and audit management.
The three solutions are further supported by leading practices in the areas of organizational model and relationships, both internal and external. The right tools and technologies can help track and manage disputes, while the leading practice may even collate all tax data into one place before utilizing data analytics, machine learning, and artificial intelligence to try and predict where future disputes may occur.
The tax environment is shifting faster than ever before and only a limited window of opportunity exists to prepare before several of these key trends converge. Companies should be careful to not let the window close on them.
The views reflected in this article are the views of the author and do not necessarily reflect the views of the global EY organization or its member firms.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Kate Barton is EY Global Vice Chair – Tax, and Luis Coronado is EY Global Tax Controversy Leader and EY Global Transfer Pricing Leader.