Canadian companies working abroad are facing increased tax scrutiny as governments around the world look to grab a bigger piece of the corporate tax pie.
According to Ernst and Young's 2012 global tax risk survey, more than half (56%) of Canadian executives surveyed said the number and aggressiveness of audits by tax agencies in the countries where they do business has risen dramatically. The problem is even more serious for executives of companies with more than $5 billion in revenue: 75% say the number of audits has increased in the past couple years.
According to Greg Noble, a Vancouver tax partner at Ernst and Young, “Tax authorities are going to try much harder to capture taxes that should have been paid … because it's very difficult to raise new taxes right now, or raise the tax rate.”
Governments facing severe budget deficits might also be fishing for more revenue through their tax departments.
The global survey found that most tax auditors are focusing their analysis on the transfer-pricing of cross-border transactions done between a parent company in one country and its subsidiary in another.
Agencies want to ensure that businesses are neither hiding profits in foreign operations nor transferring profits out of the home operation to avoid paying taxes. Another global Ernst and Young survey found that 68% of international companies had been subjected to a transfer-pricing audit last year. That's up from 52% in 2007.
“Transfer-pricing definitely appears to be a growth industry in CRA audit,” said Rick Bennett, a Vancouver tax lawyer at Borden Ladner Gervais. “The CRA has been upping its resources devoted to audit work in the international context, which includes a lot of different things, but it's an area that is, with some justification, regarded as one that's ripe for abuse, and an area they believe they may be able to recover a lot more tax money.”
Tax law interpretations
While there are numerous legitimate and long-established rules surrounding transfer-pricing and cross-border transactions, Noble noted that they remain very subjective.
“[The rules] say you have to sell at fair-market value,” Noble said. “Well, that's an easy concept to say, but difficult to prove. You'll typically find two tax authorities with a very different view as to what fair market value was and you get into a subjective debate between the two tax authorities about what is the right amount of profit to be left here or there.”
As a result of the increased scrutiny, companies increasingly face double taxation, where both tax agencies are claiming tax on the same dollar of profit. While there are dispute mechanisms like the Mutual Agreement Procedure (MAP) to deal with double taxation, the process with the CRA can take roughly two years or more to resolve. In fiscal 2010-11, it took more than 32 months for a MAP case to be resolved for a Canadian company, up from 23 months in 2009-10.
“It's a big challenge,” said Noble. “As tax authorities get increasingly hungry for tax dollars, you're going to see more and more of this double taxation and this lag time between having to pay the tax and getting your credit back by fighting through this mechanism.”
While Noble noted the CRA has remained one of the most aggressive and thorough tax regimes, Canadian companies with foreign operations have already started to face heightened scrutiny in key markets like the U.S., India and China.
Another Ernst and Young report noted that more than a dozen countries are now open to imposing high penalty rates for transfer-pricing disputes.
Noble said China has started imposing and enforcing its own transfer-pricing rules to boost its tax revenue. Russia also recently announced that it plans to institute transfer-pricing rules. India's latest budget recently proposed billions of dollars in new corporate taxes for foreign companies.
But in addition to staying on top of national tax changes, Tom Earle, manager of tax at Ritchie Bros. Auctioneers (TSX:RBA) said that keeping up with changes at local or state levels is critical. Over the past few years, for example, he's had to address Texas switching to a gross-margin corporate tax system and Ohio switching to a tax on gross receipts instead of net income.
“International tax is, by far, the most complex and fast-changing area of tax law,” said Earle, “and it's been consistently changing over the last five years I've been with the company.”
Tax scrutiny to intensify
For executives, the tax-related risks that could affect the company's bottom line is only going to get worse. The report said the vast majority of tax administrators and policy makers surveyed say they will increase their focus on corporate tax risks, particularly relating to cross-border transactions and international structures over the next three years. Almost all the tax policymakers surveyed said they expect significant growth in international tax anti-avoidance rules over the next three years.
According to the Organization for Economic Co-operation and Development (OECD), more than 700 agreements to exchange tax information between countries have been signed since 2009, yielding an additional US$17 billion in tax revenue for 20 countries. Much more is expected to be funnelled into government coffers as the number of tax havens around the world rapidly declines and the web of shared information widens.
While there is little a company can do to halt the continued evolution of tax regimes around the world, Earle said businesses should be proactive in dealing with pending changes. That has become increasingly important for the Burnaby-based global industrial equipment auctioneer that now operates in more than 25 countries.With more countries enforcing transfer-pricing requirements, Earle said companies will need to continually evaluate whether their transfer-pricing documentation and polices match company risk profiles.
“Some companies are seeking rulings and advance price agreements to get certainty on transactions. Other companies may be accepting a higher level of risk by simply relying on standard documentation or transfer-pricing studies.”
While audits have been adversarial, Noble said taking a more co-operative approach makes sense. “If I'm going to be scrutinized anyway, it's probably better to do it in a less hostile environment … so issues can be more easily resolved.”