TMC Tax Focus | Be prepared for tax scrutiny
Published on 12th May 2021
With tax authorities often sceptical about the motives behind corporate decision-making, recording and being able to demonstrate the commercial rationale can pay dividends if those decisions come under scrutiny further down the line.
This is the final part in our series of articles looking at international tax issues for multinational entities in the Tech, Media & Communications sector. In this part we look at the practical issues that arise from the evolving international tax landscape, in particular the need for companies to be able to explain and evidence the rationale behind any transactions which have significant tax consequences.
- Part One looks at recent and forthcoming VAT changes
- Part Two looks at tax incentives
- Part Three looks at the debate around profit attribution for tax purposes to digital business
- Part Four looks at anti-avoidance rules and transparency
In the crosshairs
Given some of the news coverage over the past decade it is not surprising that there is some scepticism amongst tax authorities and the wider public as to whether multinationals are paying their "fair share" of tax. It is not enough for companies to proclaim that they comply with their tax obligations – in the UK, HMRC will not take such assertions at face value, indeed recent experience is quite the opposite. The company must be able to prove that this is the case. This is not always as straightforward as it would appear.
A range of targeted anti-avoidance measures now exist where the tax treatment is directly affected if the taxpayer has entered into cross border or domestic arrangements where one of the main purposes was to avoid tax. The loan relationships regime, Diverted Profits Tax and the principal purpose test under the OECD's Multilateral Instrument are just a few examples (see earlier the Insights in this series).
If a taxpayer enters into a transaction or structures its affairs in a way that reduces its tax bill, but does so primarily for commercial reasons, then many of these anti-avoidance provisions should not cause a problem. It is vital therefore that the taxpayer can demonstrate what these commercial reasons were. HMRC is battle hardened – its working assumption is likely to be that tax was a driving factor unless there is hard evidence that other issues were more important. This is where problems can arise for taxpayers.
For example, there could be any number of valid commercial reasons for deciding to locate central shared services (such as sales and administrative support) outside of the UK, or putting interest bearing intra-group debt into UK subsidiaries. But if they are done for the "wrong" reasons, it can have adverse tax consequences. In the shared services centre example, if it is located overseas because there is existing infrastructure and staff resources in that location, this is unlikely to cause tax problems (subject to appropriate transfer pricing arrangements). If, however, it is part of an arrangement to ensure no contracts are signed in the UK – then there may be a DPT "avoided PE" problem (see the section on Tax Avoidance rules in Part Four of the series for more detail on DPT)
A question of perception
In our experience, the commercial imperatives for a decision are often taken for granted by the company – they may be factors which are widely known to the senior executives and as such they do not generate much discussion or contemporaneous documentation.
By contrast, because the tax implications are rarely straightforward, a well-run business will take professional advice on such matters. Inevitably professional reports are generated, emails exchanged and board papers are produced – all focussing on the tax implications of a transaction. We often see, when instructed after implementation, scenarios where there is no mention in contemporaneous documentation of the commercial factors or, if there is, they are briefly listed, referring in opaque terms to things like unspecified "synergies" or "optimisation" of a group structure.
When three or four years down the line HMRC asks to see all relevant information and documents, it often receives a few pages (if that) detailing the commercial aspects, and many lever arch files of papers dealing with the tax. If the available contemporaneous evidence suggests that management were concentrating on the tax consequences, the natural inference is that tax is a big factor. It is essential, therefore, that there is robust, contemporaneous evidence detailing the commercial rationale underpinning tax sensitive arrangements and that this evidence is preserved.
One solution is to ensure that when input on the tax side is sought, a proper commercial briefing is also provided. This may include a briefing note detailing the commercial considerations, but salient emails, reports, financial projections and third party advice can all provide robust evidence of the commercial rationale in due course. If there are concerns about sensitive information being shared, or legal privilege being retained, these can usually be managed by using appropriate safeguards.
Document retention policies should also be kept under review. HMRC is subject to time limits for opening investigations and assessing tax (it can rarely go back further than six years), but the underlying facts relevant to the tax liability in a given year – such as the reasons for adopting a particular corporate or financing structure – may stretch back many years to when the structure was originally implemented. A blanket six year document retention policy will therefore not always be sufficient.
The assumptions above suggest that, to some extent, there is a readily identifiable set of decisions which bring about the transactions or arrangements in question: for instance, board approval to enter a loan or restructure a corporate group. Sometimes, however, things evolve more organically. Taking the earlier example of an overseas company with sales to UK customers, there may never have been an active decision not to locate employees or infrastructure within the UK – the company might simply have relied on existing resources in other jurisdictions (when UK sales where limited) and not reviewed the arrangement as sales grew. In this example, it is harder to point to clear evidence for the commercial drivers of a decision. One approach is to undertake a search of relevant documents and emails to establish that tax was not a significant factor. Ideally the search terms, locations and date ranges would be agreed with HMRC beforehand. This does not necessarily establish the commercial factors, but the absence of any active consideration of the tax issues can at least help to rebut any presumption that tax was an important driver.
Finally, contemporaneous documentary evidence is generally the most powerful form of evidence. However, it may be necessary to provide further context or fill in the gaps by obtaining evidence after the event (for example, during an HMRC enquiry) from those who were involved at the time. If this is necessary, careful thought should be given as to who would provide such evidence and in what form. It might be appropriate for them to discuss their role at a meeting with HMRC, or a written statement could be provided (including a signed statement of truth if it was considered appropriate). This sort of evidence should be obtained as soon as it becomes clear that it may be required, not least because all memories fade with time, but also because obtaining the co-operation of relevant individuals is likely to be considerably harder if they leave the company before having provided a statement.
Osborne Clarke comment
Any arrangements with tax consequences may be scrutinised by HMRC several years down the line. Commercial factors which might seem obvious now may not be so apparent in future, and comprehensive evidence of the commercial rationale should be obtained and preserved. This can prevent timely and expensive HMRC enquiries and unexpected tax assessments in future.
We would be very happy to discuss any of these issues, provide more detailed guidance and also how they might impact on your business.