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Global Tax Audit and Controversy Risk Management Process – PART 1 OF 5

Global Tax Audit & Controversy Risk Management Process – PART 1 OF 5

Introduction

www.TaxRiskManagement.com (“TRM”) have maintained in our publications and workshops over the years that managing tax risk is one of the greatest challenges for tax departments around the world (creating the opportunities to build lasting world class relationships with Revenue Services), starting with the verification audit through to the resolution of tax controversies. A recent big 4 survey supports this contention. More than 540 companies from 18 countries took part in a fairly recent survey aimed to identify global trends in tax function priorities, time allocation and success measures.

Key aspects that emerged can be summarized as follows (key points are highlighted):

Tax risk is everywhere

… companies continue to face increased pressure on the tax function. As a result, tax functions are focused on addressing risks in every major area of the tax lifecycle – planning, provision, compliance and controversy. Improving the tax function is clearly more important than ever, with more than 90% of companies indicating this will be an important area for them over the next two years.

People are a tax risk

87% of respondents identified people issue as an important challenge facing the tax department. Companies are struggling to get enough people to staff their tax department. They are also challenged to train the people they have, with 77% of companies indicating that the lack of skilled resources is a contributing factor to tax risk.

The trend – proactive versus reactive

Today, companies report a significant increase in the time they’re spending identifying, managing, tracking and responding on tax risk. The number of companies who spend at least 20% of their time on tax risk increased over the last two years from 16% to 25%. Leading tax functions are responding by becoming more efficient and broadening their response to risk. Building linkages to other parts of the organization is becoming increasingly important.

Communication is key

According to our findings, companies that have regular communications with their board about tax risk are also more likely to report having specific measures in place to address those risks. The difference seems to be that they take a broad approach to tax risk assessment and work to efficiently leverage their people, processes and technology.

Throughout the world, any tax question or issue (before it becomes material) should be considered at a central division or consultation facility in order to determine what the approach should be to that question or issue – after being exposed to the proper factual analysis, and then to the applicable broad set of legal principles – tax and constitutional & administrative law. Without a central considering authority, one can never know in a large organization exactly where a tax review (potential or actual) may end up. Stated otherwise, group tax will not know exactly what is going on if each and every tax review is not reported to a centralized office that will then in turn decide how the matter should be dealt with.

The lessons learnt from the many clients TRM have consulted to show the following trends must be maintained:

§    up-to-date international best practice;

§    relationships with Revenue Services;

§    engagement with Revenue Services at various levels;

§    analysis and resolution of potential and actual tax reviews;

§    record keeping, filing and data securitization

The aim of this report

The aim of this report is to convince the head of group tax that the appropriate emphasis should be placed on the tax audit process through a tried and tested methodology, where this area of tax risk management can be streamlined and improved, in line with the lessons learnt by TRM in acting for multi-national corporations in reducing potential tax exposure on tax controversies from 100% to a mere 3%.

The focus is a pro-active engagement with Revenue Services, supported by a process (analyzing & strategizing the facts & law, through to a data securitization process) to deal with potential tax exposure issues before they become material risks. This precise methodology is currently not followed by most corporations as expounded in the textbook ‘Tax Intelligence’ written by Prof. D N Erasmus, the Chairman of TRM. It is a process that has significant merit in the correct circumstances.

These circumstances include a global environment where there is:

§         ‘country collusion’ between Revenue Services;

§          increased verification audits through Large Tax Units (LTU’s), and in the areas of indirect taxes, transfer pricing, and anti-avoidance;

§          more litigious Revenue Services; and

§          global tax administration.

The challenge in convincing the head of group tax is that this area of tax risk should be a high priority, and should be implemented on a broad scale across the group, region by region, in a staged manner. The urgency with which this must be done will become apparent from the results of the survey, that will justify the additional time and expense. It is also noteworthy that the benchmark case study recognizes this as a high priority and has commenced an implementation process.

Analysis of various sources to compile this report

This report has been compiled after analyzing various information sources.

The OECD Centre for Tax Policy and Administration released its first report dated 28 January 2009, prepared by the Forum on Tax Administration under the then leadership of Pravin Gordhan. The report is headed Tax Administration in OECD and selected non-OECD countries: Comparative information series.

In addition to this, and the analysis of various EU and Latin America Tax Reform and Development texts, numerous survey questions were prepared. Careful analysis was made of tax policies, processes and procedures to create a benchmark against which group tax information can be compared.

The OECD report covers 43 countries. We applied the information of that report to one of the top 50 taxpayers in South Africa, and established the following:

Of the 43 countries that participated in the report, 15 countries group operations in them. They are as follows:

EUROPE: Czech Republic, Germany, Hungary, Poland, Romania, Italy, Netherlands, Spain & UK

ASIA: Australia & China

AFRICA: South Africa

NORTH AMERICA: Canada, Mexico & USA

LATIN AMERICA: Non – although many Latin American countries are in a tax transition phase, and are in the process of following the tax reforms initiated in some of the former Eastern Bloc countries that have joined the EU.

In addition to the above, the Group Financial Statements make the following disclosure:

Company law requires the directors to prepare consolidated financial statements for each financial year. Under that law the directors have prepared the consolidated financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union. The consolidated financial statements are required by law to give a true and fair view of the state of affairs of the group and of the profit or loss of the group for that year.

This requires comment – During February 2006 the FASB and the IASB concluded a Memorandum of Understanding stating their intention to seek a convergence of their standards and interpretations by 2008. FIN 48 is the FASB standard, requiring a two-step evaluation:

§          the business determines whether it is more likely than not (50% or greater likelihood) that a tax situation would be upheld in an examination, including resolution of any potential ensuing litigation process, based on the technical merits of the tax situation;

§          the tax situation that meets the more likely than not recognition threshold is measured to determine the amount to recognize on financial statements.

As a result, the advent of FIN 48, like SOX 404, underpins the requirement for businesses to embark upon a systematic TRM process to limit and expose, with the view to efficiently minimizing the incumbent tax risks. IFRS looks to do exactly the same.

The group has an extensive worldwide TRM process in place. The process works on a decentralized basis where each business unit reports to group tax risks when they become material.  The gap between the commencement of verification audits and the creation of a tax dispute (when it becomes material) is an area of TRM that we propose requires more careful attention, in each region, to ensure better risk management of any potential emerging tax risk exposure, before it becomes material.

TO BE CONTINUED…

Prof D N Erasmus is teaching the International Tax Risk Management class for the LLM in International Taxation at Thomas Jefferson School of Law, this summer semester. He is co-author of the IBFD Tax Risk Management textbook available from www.IBFD.org, and Tax Intelligence (on Tax Risk Management) available from www.Amazon.com.  Connect with him on TaxConnections.

 

Oracle eBTax and Operating units

With the introduction of Oracle R12 and the greater emphasis on shared service centres, can you afford not to use multiple Operating units especially when considering your indirect tax solution using Oracle Financials?

The challenged faced by any company implementing a new ERP solution, whether a single entity or a global conglomerate, is to capture the complex business requirements and yet keep the structure as simple as possible. Creating a highly complex organisation structure is likely to lead to greater data processing needs as well as a more labour intensive maintenance requirements. There is also a risk that the solution initially designed to help the company, ultimately leads to issues that end up consuming more resource.

Any solution architect will be considering this when they design the organisation structure deciding the best approach for the number of ledgers, what legal entities will use these ledgers and how many operating units will be needed to capture the data from the sub ledgers such as the Payables or Receivable modules.

The 11i approach was often to keep things as simple as possible, with one ledger where possible and only one operating unit linked to this ledger. The primary driving factor was the time it would take to run reports, opening and closing the month and entering data across the different legal entities. Each additional Operating unit meant that a new responsibility was required and this meant that a user would have to switch between these responsibilities each time they wanted to enter any data or do any month end processes for example. If you had 10 legal entities, this meant that the same task, if 10 operating units were used, one for each Legal entity, would have to be repeated each time. This of course would take a huge amount of time compared to one operating unit that all 10 legal entities were assigned to!

Oracles’ ‘Release 12’ solution change the playing field and ultimately the way the organisations could be established. First, ledger sets allowed multiple ledgers to be linked together as a ledger set providing that the same calendar and chart of accounts was used. A ledger set could then be assigned to a responsibility effectively giving access to the data in all of those ledger contained in the ledger set! Second, and more importantly, the ability to create security profiles meant that access to operating units and inventory orgs could now be combined together. This means that those 10 legal entities could now have 10 operating units per legal entity and added to one or multiple security profiles. A security profile and not an individual operating unit could now be assigned to a responsibility, giving it access across all 10 operating units! So now the ability to maintain simplicity with one responsibility to enter data and process month end is achieved but with the added benefits of the diversification that multiple operating units can bring.

Andrew Bohnet

Using DTTs to win domestic tax disputes – Have a look at this perfect example

Tax authorities have this gross tendency of ignoring the provisions of Double Taxation Treaties (DTTs) when it comes to determine the place of tax domicile of (wealthy) individuals who dispose of multiple international abodes. They rely usually on credit card transactions, utilities bills and other similar proof to back up their claim that their “tax pigeons” have spent a period longer than the legendary 183 days threshold per tax year in their jurisdiction. We tax professionals have often the tendency to dispute their claim by trying to collect evidence to the contrary whilst the best strategy is to look into the DTTs. Indeed, the OECD model treaty provides that when an individual has two or more international abodes, then one should look into his center of (personal & economic) vital interests to determine his tax domicile. DTTs provisions prevail on domestic laws hence providing superior arguments to us tax professionals to counter Revenue Services claims that are based solely on domestic tax laws. In this scenario the 183 days threshold will move from a premier importance into a subsidiary role under the DTTs. Only in the (rare) cases where the center of vital interests of a tax subject could not be clearly determined that the Revenue Authorities will be allowed to use the 183 days criteria. Voilà!

15 US 2012 Tax Facts for Americans Living and Working Abroad

By Don D. Nelson, Attorney, C.P.A.
Kauffman Nelson LLP

If you are a US Citizen you must file a US tax return every year unless your taxable income is less than $15,700 – for a joint return or $ 9,750 – for a single return (these amounts are for 2012 and are lower amounts for earlier years) or have self employment-independent contractor net self employment income of more than $ 400 US per year. You are taxable on your worldwide income regardless of whether you filed a tax return in your country of residence. You must file a tax return each year if you income exceeds the amounts stated above even if you owe no tax.

As an US expatriate living and working abroad 4/15, your 2012 tax return is automatically extended until 6/15 but any taxes due must be paid by 4/15 to avoid penalties and interest. The return can be further extended until 10/15/10 if the proper extension form is filed.

For 2012 if you are a qualified expatriate you get a foreign earned income exclusion (earnings from wages or self employment) of $95,100, but this exclusion is only available if you file a tax return. You must qualify under one of two tests to take this exclusion: (1) bonafide resident test or (2) physical presence test. You can read more about how to qualify in IRS Publication 54.

If your spouse works and lives abroad, and is qualified, she or he can also get at $95,100 foreign earned income exclusion.

If your foreign earnings from wages or self employment exceed the foreign earned income exclusion you can claim a housing expense for the rent, utilities and maintenance you pay if those amounts that exceed a minimum amount of $15,216 up to a maximum amount which varies by your country of residence.

You get credits against your US income tax obligation for income taxes paid to a foreign country but you must file a US tax return to claim these credits.

If you own 10% or more of a Foreign corporation or Foreign partnership (LLC) you must file special IRS forms each year or incur substantial penalties which can be greater including criminal prosecution if the IRS discovers you have failed to file these forms.

If you create a foreign trust or are a beneficiary of a foreign trust you may be obligated to file forms 3520 and /or 3520A each year to report those activities or be subject to severe penalties. Foreign foundations and non-profits which indirectly benefit you may be foreign trusts in the eyes of the IRS.

Your net self employment income in a foreign country (earned as an independent contractor or in your own sole proprietorship) is subject to US self employment tax of 15.3% (social security) which cannot be reduced or eliminated by the foreign earned income exclusion. The one exception is if you live in one of the very few countries that have a social security agreement with the US and you pay that countries equivalent of social security.

Forming the correct type of foreign corporation and making the proper US tax election with the IRS for that corporation may save you significant income taxes and avoid later adverse tax consequences. You need to take investigate this procedure before you actually form that foreign because it can be difficult to make that election later.

If at any time during the tax year your combined highest balances in your foreign bank and financial accounts (when added together) ever equal or exceed $10,000US you must file a FBAR form with the IRS by June 30th for the prior calendar year or incur a penalty of $10,000 or more including criminal prosecution. This form does not go in with your personal income tax return and is filed separately to a different address.

In the past several years the IRS has hired thousands of new employees to audit, investigate and discover Americans living abroad who have failed to file all necessary tax forms. These audits have begun and will increase significantly in the future. The IRS gets lists of Americans applying or renewing for US passports or entering the country. They will compare these lists with those who are filing US income tax returns and take action against those who do not.

Often due to foreign tax credits and the the foreign earned income tax expats living abroad who file all past year unfiled tax returns end up owing no or very little US taxes. The IRS has several special programs which will help you catch up if you are in arrears which will reduce or possibly eliminate all potential penalties for failing to file the required foreign asset reporting forms. We can direct you to the best program for your situation, prepare the returns and forms and represent you before the IRS.

Beginning in 2011 a new law went into effect which requires all US Citizens report all of their world wide financial assets with their personal tax return if in total the value of those assets exceed certain minimum amounts starting at $50,000 . Failure to file that form on time can result in a penalty of $10,000.

Certain types of income of foreign corporations are immediately taxable on the US shareholder’s personal income tax return. This is called subpart F income. The rules are complex and if you own a foreign corporation you need to determine if these rules apply to you when you file the required form 5471 for that corporation.

If you own investments in a foreign corporation or own foreign mutual fund shares you may be required to file the IRS forms for owning part of a Passive Foreign Investment Company (PFIC) or incur additional, taxes and penalties for your failure to do so. A PFIC is any foreign corporation that has more than 75% of its gross income from passive income or 50 percent or more of its assets produce or will produce passive income.

Visit my Tax Professional Profile Page to download your 2012 US tax return questionnaire prepared expressly for Americans living abroad.  Please “Connect” with me on TaxConnections and we will review your completed questionnaire for a fixed fee quote for the preparation of your return.

Don D. Nelson, US Attorney, CPA
Kauffman Nelson LLP
Dana Point, California 92629 USA

We have been preparing tax returns and assisting US clients located in over 50 countries around the the world for over 30 years. We also assist US Nonresidents meet their US tax obligations and return filing requirements. We offer mini consultations (with attorney client privilege) to answer your tax questions and resolve your tax issues.

The Substantial Presence Test for U.S. Residency Status

Residency Status Determines Your Tax Bill

If you are neither a citizen nor a permanent resident of the United States, you must determine your U.S. residency status for tax purposes. If you are a nonresident for tax purposes, you file a special tax form (Form 1040NR), pay tax only on U.S. source income, are subject to special rates on investment income, and might benefit from exemptions from income conferred by the tax treaty between the United States and your home country.

If you are a resident taxpayer, you must report your worldwide income for U.S. tax purposes. You are also eligible to claim deductions and credits available to U.S. citizens. You can file Form 1040, 1040A, or 1040-EZ, whichever is applicable to your situation, and if you are married you can file a joint return with your spouse. Additionally, you still might be eligible for treaty benefits in certain situations.

It’s Not Your Immigration Status That Counts

Your residency status for tax purposes is completely separate from your immigration status. Even though you arrived in the United States as a non-immigrant visa holder, you might be a U.S. resident for tax purposes.

So, if you are not a citizen or permanent resident of the United States, how do you determine your residency status for tax purposes? You look to the “substantial presence test” set forth in Section 7701(b)(3) of the Internal Revenue Code. To meet the substantial presence test for the current year, you must be physically present in the United States during a period you are not an “exempt individual” on at least:

1) 31 days during the current year, and

2) 183 days during the three-year period that includes the current year and the previous two years, counting:

* all of the days you were present in the current year, 
* 1/3 of the days you were present in the first preceding year, and
* 1/6 of the days you were present in the second preceding year.

For example, let’s say you were present in the United States for 120 days in 2010, 222 days in 2011, and 80 days in 2012. In applying the substantial presence test to 2012, you count 20 days from 2010 (120 x 1/6) +74 days from 2011 (222 x 1/3) +80 days from 2012 = 174 days. That means that you did not pass the substantial presence test (< 183) and are not a resident of the U.S. for tax purposes for 2012. 

Exempt Individuals

An exempt individual is someone whose days in the United States are not counted toward the substantial presence test. It is not someone who is exempt from taxation. If you are an exempt individual, you are a nonresident for tax purposes until you are no longer an exempt individual, or until you receive permanent residency status. You are generally in this category if you are:

* Temporarily present in the United States as a foreign government related individual (A or G visa holder). 
* A teacher or training temporarily present in the United States under a J or Q visa, who substantially complies with the requirements of the visa.
* A student temporarily present in the United States under an F, J, M or Q visa, who substantially complies with the requirements of the visa.
* A professional athlete temporarily present in the United States to compete in nature will sporting event.

Teacher or trainee. If you are a teacher or trainee temporarily in the United States on a J or Q visa, and you have been present in the United States during no more than two calendar years out of the last six calendar years, you are an exempt individual. For example, let’s say you entered the U.S. on December 28, 2009 as a trainee on a J visa, and stayed in the U.S. continuously through 2011. Your days in the United States are exempt from the substantial presence test for 2009 and 2010, but they all count in 2011 and later years if you remain in the United States.

There is an exception to this rule. If all of your compensation during the prior six years  is from a foreign employer, the two year exemption period is extended to four years.

Student. If you are a student temporarily in the United States on an F, J, M, or Q visa, and you have been present in the United States during no more than five calendar years, you are an exempt individual. For example, let’s say you entered the U.S. on June 4, 2007 as an F-1 student visa holder, and have remained here until 2012. You are a nonresident alien for 2007, 2008, 2009, 2010, and 2011. If you are in the U.S. for at least 183 days in 2012, you will be a resident for tax purposes in 2012.

Members of the family. If you are an exempt individual, members of your immediate family who are with you in the United States on visas derived from your visa (J-2, F-2, etc.) are also exempt individuals.

Dual Status Aliens

If you are classified as a resident for tax purposes during part of a year, and a nonresident for the rest of the year, you are a dual status alien for tax purposes and are required to file a dual status return. This sometimes occurs during the year you enter the United States, during a year in which you change your visa status from an exempt individual to a non-exempt individual, or vice versa, or when you become a permanent resident.

There are several provisions, both statutory and through tax treaties, that allow you to elect to be treated as a full-year resident, a full-year nonresident, or a dual status alien in particular situations, if the choice is beneficial.

Confused?

Well, this is a confusing topic, but one that is very important. Don’t worry – there is an interactive questionnaire at www.form1040NR.com that you can use to guide you to the correct result. In the header menu go to “Your Tax Residency” and answer the questions (after reading them very carefully). If you are still confused, I would be happy to answer your questions.

FATCA Intergovernmental Agreements

We originally posted on Thursday, November 8, 2012, U.S. Engaging with More than 50 Jurisdictions to Curtail Offshore Tax Evasion “Global cooperation is critical to implementing FATCA in a way that is targeted and efficient,” said Treasury Assistant Secretary for Tax Policy Mark Mazur. “By working cooperatively with foreign governments and financial institutions, we are intensifying our ability to combat tax evasion while minimizing burdens on financial institutions.” BNA has a good analysis of the of the composition of current (and future?) specifics of FATCA Intergovernmental Agreement.