The International Who’s Who of Corporate Tax Lawyers has brought together Michael Schler of Cravath Swaine & Moore, Ana Lucía Ferreyra of Teijeiro & Ballone Abogados and João Magalhães Ramalho of PLMJ to discuss stricter enforcement, reconciling international and domestic tax regulation and transfer pricing and greater transparency.
Cravath Swaine & Moore
Ana Lucía Ferreyra
Teijeiro & Ballone Abogados
João Magalhães Ramalho
Who’s Who Legal: Many lawyers commented on the continued rise in tax litigation over the past year, caused by a stricter approach to enforcement from tax authorities. Do you expect this to be a permanent change in approach from regulators, and have you seen more legislative reform as a result of the increasing tax disputes?
Michael Schler: In the US, the tax authorities are increasingly challenging transactions that reach results that they consider unduly favourable to taxpayers, whether or not the tax benefits result from literal compliance with the Internal Revenue Code and regulations. Many of the challenges to these transactions are based on various anti-abuse rules or doctrines such as the economic substance doctrine or form/substance doctrine. Taxpayers have lost many if not most of these cases in the courts, since judges are increasingly unwilling to allow tax results that they see as being “too good to be true”.
This approach by the tax authorities is likely to continue. The principal legislative reform in recent years has been the codification of the economic substance doctrine. The scope of the doctrine is still very unclear, but the effect is likely to make taxpayers less willing to engage in aggressive transactions.
Ana Lucía Ferreyra: Argentina has not experienced a particular rise in tax litigation over the past year. Although rulings affecting tax compliance have increased (eg, new and diverse regimes demanding taxpayers to provide economic and tax-related information) and the tax authorities have considerably focused on enforcement, this trend has not resulted in a rise in tax litigation.
It is probable that this comes from the fact that the strict approach to enforcement in Argentina has been combined with amnesty and regularisation regimes enacted during the past years. In effect, an amnesty regime coupled with a very convenient regularisation plan issued in 2009 led some existing or potential disputes (either at the audit/administrative or judicial level) to be aborted, therefore leading to a drop in the number of litigated cases. A new amnesty regime was also implemented early this year, so a similar effect would be expected.
As a result, since the strict approach to enforcement has been (and will be) influenced by the amnesty and regularisation regimes, the typical effect on increasing tax litigation has not stemmed.
Finally, unlike other countries or jurisdictions, where tax reforms are enacted right after a relevant case or even before them as an anticipation of an expected negative outcome, this type of behaviour is not very frequent in Argentina.
João Magalhães Ramalho:When countries in general need to balance their budgets, one important way to achieve this is by increasing tax revenues. For this reason, the continued rise in tax litigation appears to be a trend that is here to stay.
In contrast with the tax litigation we have traditionally seen in the past, which tended to arise from typical tax avoidance schemes, the focus is increasingly on implementing new legislation to fight avoidance in the form of tax base erosion and profit shifting. This means that not only will tax litigation continue to rise but it will also be broader in scope.
In fact, as many developed economies are being forced into harsh austerity programmes because of widening budget deficits, questions are being raised about national tax policies and their impact on the global economy. If, up to now, the discussion has been focused on how to fight tax havens, the global debate now tends to focus on developed economies such as the Netherlands, Luxembourg or Ireland that have sucked up corporate investment by encouraging companies to avoid hefty tax bills at home.
This means that until tax harmonisation on corporate income is agreed, we will see an increasing tendency by the stronger economies to impose more and more tax avoidance rules so as to avoid losing part of their tax revenues, but at the same time, we will also see adjustments in more tax-friendly jurisdictions in order to comply with the new rules so that business stays as usual.
At a domestic level, the recent report issued by the Portuguese CIT Tax Reform Group, which is currently under public discussion, shows precisely this trend. There is a clear effort by the Portuguese state to create a more sophisticated and less burdensome tax system. However, Portugal does not want to miss the bandwagon in terms of tax competitiveness and the government has announced several measures to cut tax rates and to bring the system closer to other European jurisdictions.
Who’s Who Legal: In your jurisdiction how difficult is it to reconcile international and domestic tax regulation in your advice to clients? What are the major concerns for clients in your country at this moment in time?
Michael Schler: Differences between international and domestic tax rules can be either helpful or harmful to taxpayers. In the US, they can be helpful because they permit taxpayers to avoid tax in multiple jurisdictions, eg, through the use of hybrid instruments or hybrid entities. They can be harmful if they result in double taxation, such as different national standards for intercompany pricing or different rules concerning the source of income. In addition, the US only gives a foreign tax credit for a foreign tax that is considered “compulsory”, and the US tax authorities may claim that the US taxpayer did not make sufficient efforts to contest the foreign tax before paying it.
In the US, double taxation can sometimes be avoided through the application of tax treaties, including competent authority proceedings thereunder. However, the US does not have tax treaties with all its major trading partners. Even if there is a treaty, the treaty may not resolve all issues of double taxation, and competent authority proceedings take an extremely long time and are not always successful.
Ana Lucía Ferreyra: It is not difficult in Argentina to reconcile international and domestic tax regulations. Domestic tax regulations (on international and pure domestic tax issues) generally follow international tax standards. There are not unique approaches giving rise to contradictions and/or implementation problems. With a few exceptions, tax treaties have been also structured following usual international standards (eg, OECD or UN models). The main problem, however, is that the Argentine treaty network is very limited and there are no precise guidelines on the granting of treaty benefits giving rise to a considerable level of uncertainty.
Notwithstanding the above, at this moment in time, the major concern for clients does not derive from a “tax regulation” but rather from certain exchange control restrictions. Tax planning on investment and divestment has been extremely influenced by these restrictions.
João Magalhães Ramalho: As a result of the current crisis, the Portuguese economy is clearly split into two different realities. On one side we have the “old” economy, headed by those companies that mainly sell their products domestically and are fighting for survival, and on the other side, the “new” economy made up of the companies that have left their comfort zones and are exporting and expanding. A common factor applies to both the “old” and “new” economy companies: the major concerns our clients face are enormous tax compliance obligations which are time-consuming and the source of much unnecessary tax litigation. Additionally, clients say one of the biggest competitive issues is the extremely high rates of VAT, CIT and social security contributions, which are killing private consumption and the capacity of companies to invest and grow. At an international level, “new” economy clients face the problems of Portuguese participation in the exemption regime, in particular when relating to profits sourced outside EU countries, and financing structures, neither of which are competitive.
Who’s Who Legal: Transfer pricing work has continued to be a prevalent area for international lawyers over the past year. What are the reasons for the high levels of activity in this area, and what do you consider to be the future implications for clients?
Michael Schler: It has become clear in recent years that many multinational corporations have applied transfer pricing rules, properly or not, to cause significant amounts of income to be reported solely in jurisdictions with a low tax rate or no tax at all. Many countries have realised only recently the large amounts of tax revenue that are at stake. The US Internal Revenue Service has imposed new restrictions in recent years, and legislative proposals would go even further. The BEPS report by the OECD has also called attention to this issue.
It seems likely that the transfer pricing rules will become stricter in the future on an international basis. The principal question seems to be whether a pure “arm’s length standard” will continue to apply on an entity-by-entity basis, or whether the new rules will contain elements of a global allocation of income with less regard to legal formalities of different entities. Some say that the latter approach is necessary in order to ameliorate the problems created by the current system, but others say that this approach would lead to great uncertainty and significant risk of double taxation.
Ana Lucía Ferreyra: Argentine transfer pricing rules are quite recent; they have been in force for less than 15 years. Therefore, the recent increase in transfer pricing work (principally tax litigation) is a natural evolution of that fact. In addition, the tax authorities are becoming more sophisticated on transfer pricing issues demanding taxpayers to modify their practices on the matter and be prepared to be scrutinised and to discuss the accuracy of the criteria adopted. It is also expected that the sophistication of the tax authorities will result in the effectiveness of future audits and, eventually, in further disputes at courts.
João Magalhães Ramalho: Cross-border intra-group transactions trigger the need for groups to interact and comply with the different tax rules of several different jurisdictions. Most of these jurisdictions have CFCs and transfer pricing rules to avoid tax erosion and profit shifting and this requires specialised advice from local and international lawyers. Considering the increasing discussions promoted by the OECD and the G20 finance ministers on clamping down on tax avoidance, we predict that transfer pricing issues will become more and more significant within the context of the implementation of successful tax strategies.
Who’s Who Legal: Several lawyers have highlighted the increasing public pressure on NGOs to report their tax practices. Do you think this will be an enduring trend? Will such pressure lead to greater transparency of corporate tax structures in the future?
Michael Schler: In the US, there is a very strong tradition that tax returns are private information (except for returns of candidates for public office). So far, this has applied to corporate returns as well as individual returns. In fact, even for a US public corporation, it is generally impossible to determine from publicly filed information how much US federal income tax it has actually paid in a given year. It seems unlikely that US corporations will be required to make significantly more public disclosure in the near future.
However, tax authorities are increasingly coming to believe that they need to see a corporate group’s overall worldwide tax structure, and income reported to each jurisdiction, in order to determine whether the proper amount of income is reported in their own jurisdiction. As a result, there is likely to be increasing pressure for corporations to broaden their disclosures to the various tax authorities in jurisdictions in which they file returns, even if such information is not made public.
Ana Lucía Ferreyra: I believe the public pressure on NGOs to report their practices will be indeed an enduring trend and will lead to greater transparency not only with regard to corporate tax structures but also to corporate practices in general. The Argentine experience in this regard justifies my words. In fact, after many years of avoidance structures involving donations and contributions to NGOs used to erode the taxable basis, Argentina has started to tackle the problem.
Under current law, and having the rules evolved to a very strict scheme, the allowance granted to the donor or contributor not only is limited to a certain amount (ie, 5 per cent of the net taxable basis) but also depends on the tax exempt status of the NGO receiving the contribution.
In turn, NGOs are subject to strict scrutiny upon the request of the exemption certificate and during their life. Donations and contributions must be made through formal means (eg, wire transfer, credit card). NGOs are also obliged to file special tax returns and provide information on the donations received on a yearly basis.
João Magalhães Ramalho: As mentioned above, tax revenues are the key to healthy budgets. In this context, as in some cases NGOs have aggressive tax planning schemes, they will certainly be on the radar of the legislators and tax authorities in the coming years. Precisely following this trend, Portugal has recently reviewed the tax incentives that were being granted to foundations and similar entities, and the Portuguese CIT Tax Reform Group is currently considering new measures to achieve greater tax transparency.