Narrow tax bases in most of the developing countries mean that Revenue Authorities have become more unreasonable and aggressive in their approach
By David K Baliraine
Global tax risk and controversy are on the rise globally, especially for multinational enterprises (MNEs), and this is driven by a number of factors. The first part of this article is devoted to examining the general trends in the global tax landscape within which the MNEs operate in order to set the background. Later in the article, the various phases in the tax risk management process, and the tools available to manage risk under each phase are highlighted. The article then concludes by highlighting the risks created by tax controversy.
First and foremost, businesses have become very dynamic, with transactions being structured in ways that were never envisaged at the time the tax laws were being enacted. We are now talking about e-business, digital economy, block-chain, robotics, to mention a few. All these developments present new challenges for Revenue Authorities, MNEs and their tax advisors alike.
Secondly, the global tax landscape is more volatile and contentious, hence causing more tax disputes and controversy. We have seen a plethora of tax reforms both in the United States and in the European Union coupled with the famous Brexit in the United Kingdom. All these developments have far-reaching ramifications for MNEs wherever they operate, including in the developing world.
Thirdly, Revenue Authorities around the world have become more aggressive and focussed on transactions taking place in their jurisdictions, especially by MNEs. The G20 countries as well as the member countries of the Organisation for Economic Cooperation and Development (OECD) and the Africa Tax Administration Forum (ATAF) have been at the forefront of driving this agenda. As the Ethiopians say, "The man that marries a beautiful wife, and the one that grows corn by the roadside, have the same problem"! The MNEs are the proverbial man that married a beautiful wife; every Revenue Authority wants to grab a share of what they perceive as income generated from its territory.
Fourthly, the rapid pace of tax law changes creates more tax risk and controversy since taxpayers find themselves always aiming at a moving target in their tax compliance agenda. In the wake of the finalisation of the OECD's Base Erosion and Profit Shifting (BEPS) Project, many countries have embarked on a flurry of tax law changes, ranging from the traditional amendments to complete overhaul of tax laws. For example, Kenya, Uganda and Tanzania have in the past two or three financial years effected a number of amendments in their domestic tax laws; Rwanda, on the other hand, has taken a more radical approach in the past three years, issuing completely new Income Tax and Value Added Tax Laws as well as cancelling its Double Tax Treaty with Mauritius and negotiating an entirely new Treaty.
We are also witnessing increased information sharing among Revenue Authorities, presenting new challenges for multinational companies (MNEs). In the developed world, it is not uncommon for a multinational group to be handling a tax issue with the Tax Administration in one territory, only for follow-up queries on the same subject to be raised by the Tax Authority of another jurisdiction in which they operate. On the African continent, the Africa Tax Administration Forum (ATAF) is spearheading this. At the tail- end of July 2018, during my tour of duty in Rwanda, I was privileged to attend the ATAF High Level Tax Policy Dialogue that took place in Kigali. The subject of information sharing was high on the agenda; therefore, MNEs cannot afford to adopt a business-as-usual approach to their tax compliance agenda in Africa anymore.
Additionally, narrow tax bases in most of the developing countries mean that Revenue Authorities have become more unreasonable and aggressive in their approach and interpretation, especially when it comes to grey areas in the law as well as borderline cases, in order to meet increased tax revenue targets. For instance, Uganda Revenue Authority was tasked to collect about Sixteen Trillion Uganda Shillings last financial year; this has been raised to about Twenty Trillion for the current financial year. Hence, taxpayers should not expect to be faced with an overly reasonable taxman. As the Nigerian saying goes, "The frown on a goat's face does not prevent it being taken to the market for sale"!
In a nutshell, all the above trends imply that taxpayers and their business advisors must take a more holistic view of the tax legislative and regulatory environments within which they operate if they are to remain on top of their tax risk management agenda.
But, what is a tax dispute or controversy?
This normally arises when the Revenue Authority carries out a tax audit or tax investigation and raises an assessment or takes a decision that is not acceptable to the taxpayer. Tax disputes are, therefore, objections or appeals against the decisions of the Revenue Authority regarding the application and effect of tax laws on the affairs of the taxpayer. In other words, where there is no objection to the decision of the Revenue Authority, or an appeal against any of its decisions, then there is no dispute.
Phases of Tax Controversy Management
Tax risk and controversy is managed the same way we manage disease epidemics. There are broadly four (4) phases in tax controversy management i.e prevention, preparedness, treatment and aftercare. In each of these phases, different tools and practices can be used or applied. Such tools include Alternative Dispute Resolution (Arbitration, Mediation and Conciliation) and Litigation. We now examine each phase in a bit more detail, including the tools that can be applied.
Prevention Phase - This is the most important phase in tax controversy management. Once you get things wrong at this phase, then you are likely to grapple with tax controversy all along your business lifecycle. At the planning and implementation stage of new tax structures, new products, new services and entry into new markets, you have got to do some form of tax planning and structuring. Sales & Marketing as well as Research & Development personnel should be conscious of the tax risks inherent in their drive to roll out new products and enter new markets. Innovation is crucial for every business in order to retain competitiveness; however, this should be done with an eye on the potential tax risks and how they can be proactively managed right from the outset. Likewise, if you plan to send your employees to new markets/ countries to explore business opportunities for extended periods, you need to beware of the risk of creating a taxable presence (technically known as a nexus or permanent establishment) in that jurisdiction, which would require you to file income tax returns and pay company tax to the Revenue Authority in that country. In the event that the tax law is not clear on the tax treatment of a new structure you plan to implement; it would be good risk management practice to seek an upfront tax ruling on the matter from the Tax Administration. Take the example of multinationals wishing to invest in East Africa; it always appears fashionable for them to locate their head office in Nairobi and then establish branches in Kampala, Dar es Salam and Kigali. However, under Kenyan income tax law and practice, all branch employees of companies that are headquartered in Kenya are supposed to be included on the Kenya payroll, and payroll taxes paid to the Kenya Revenue Authority accordingly. That would, of course, imply double taxation since those employees are subject to payroll taxes in the jurisdictions where the branches are located!
At the prevention stage, therefore, one needs to consider questions like: how do you reflect items from a compliance and reporting perspective? How robust should the documentation be? How should the relevant documents, contracts or agreements be worded from a tax perspective? Do we need to obtain a private ruling and/ or opinion from the Revenue Authority? What tools can be used or implemented to mitigate tax controversy along the way?
Preparedness Phase - When the taxpayer, their tax advisor or lawyer notices that something is wrong with the tax declarations, but the Tax Administration is not yet aware of the issue, preparedness is highly advisable. You have got to consider issues such as: where does the burden of proof lie? Is it with the Revenue Authority or the taxpayer? What remedial options exist? Can you do a self-declaration by amending the relevant tax return? What are the relevant facts and their relative importance? How do you manage a potential dispute process? The answers to all these questions are important; however, the most important factor, in my experience, is the risk appetite of the taxpayer. Those with a low risk appetite will normally opt to amend their tax return and pay the principal tax, then engage the Revenue Authority to negotiate potential waiver of penal taxes and interest.
On the other hand, those with a high risk appetite will opt for the audit lottery i.e wait for the Revenue Authority to carry out an audit; if the issue is discovered, they will pay through the nose, but if not unearthed, they will have a good payday.
Treatment Phase - When an audit or tax investigation has been carried out by the
Revenue Authority, and tax adjustments are proposed or discussions thereon are ongoing, you have to consider issues like: How do you narrow the scope of the matter in dispute? What remedies are available? For example, you can pay the tax not in dispute even before the matter is resolved. What are the consequences of each dispute resolution tool available, and what is the most desirable option? Do you want to adopt a conciliatory or aggressive approach to the dispute? For those readers who belong to my faith, conciliation is like going to a Priest to receive the sacrament of confession! Are there any alternative dispute resolution mechanisms available, such as arbitration, mediation or conciliation? How do you prepare an objection and/ or appeal? If you opt for an aggressive approach, then litigation is the way to go; you need to consider hiring the services of a lawyer to represent you in the Tax Appeals Tribunal or in Court.
Aftercare Phase - Under this phase, you need to consider questions like: What is the best way to deal with the dispute outcome? What are the consequences of the outcome for tax reporting requirements? What other taxes may be triggered by the outcome? Was the issue in dispute a one-off or recurring in nature? Can internal processes, procedures and practices be changed to address the issue e.g by changing the accounting system? Can a closing agreement be reached with the Revenue Authority i.e can the treatment of the transaction on a go-forward basis be agreed upfront? Can the issue be resolved without triggering other tax consequences? Is double tax relief available after settlement of the issue?
What are the risks associated with tax controversy?
Generally, tax controversy brings with it financial, operational and reputational risks. Getting it wrong can lead to astronomical penal taxes and interest payments. Tax compliance is increasingly costing organisations a fortune as tax shocks are heavily punished by investors, with potential drops in share prices especially for listed entities. Top managers and directors can end up losing their jobs in the process.
Tax has become a corporate governance issue, and company officers are becoming personally liable for any misreporting of the tax numbers. Companies can no longer afford to delegate the tax compliance function to an Assistant Accountant who does not even attend top management meetings, let alone meetings of the Board of Directors. Tax should be accorded due attention at the strategic level.
Multiple tax controversies can create negative perceptions within the Revenue Authorities and the general public which increasingly sees tax as a corporate social responsibility (CSR) issue. In extreme cases, the public may boycott the consumption of goods and services produced by the errant company.
Lastly, but by no means least, a tax issue in one jurisdiction can suddenly surface in another jurisdiction faster than multinationals are prepared for, as Revenue Authorities carry out joint and simultaneous tax audits, as well as sharing information as alluded to earlier in this article.
The good news for multinationals, and any other taxpayers grappling with potential and/ or actual tax controversy, is that there are those of us whose business is to wake up every day and assist taxpayers at all phases of the tax controversy conundrum to proactively manage their risks.
The writer is an Associate Tax Director at Ernst & Young Uganda