Resolving Global Tax Conflicts

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Marc Levey, New York, B&M Monique van Herksen, Amsterdam, B&M Moises Curiel-Garcia, Mexico City, B&M Sai Ree Yun, Korea, Yulchon

2009 Asia Pacific Transfer Pricing Conference

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• The Audit Process

– The team, team meetings and information document requests

– Notice of Proposed Adjustment (NOPA) – 30 Day Letter

– Notice of Proposed Deficiency

• Each event triggers a strategic move for Taxpayers

– Resolving cases at Audit

– Appeals or Simultaneous Appeals & Competent Authority

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30-Day Letter & RAR

Notice of Deficiency

Fast Track Settlement

Early Referral Procedure (“ERP”)

IRS Appeals Office Competent Authority

Tax Court

Refund Forums Denial of Refund Claim

Audit/Notice of Proposed Adjustments

Post-Appeals Mediation

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Taxpayer’s Dispute Resolution Strategies

• Multiple Objectives –

– Resolve controversy. What is “success?” – Avoid penalties.

– Manage financial statement implications. – Minimize potential double taxation.

– Control costs of dispute.

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IRS Appeals

• Examination “Ex Parte” Rules

• Opening Conference

• Appeals mission – fair resolution based on litigation

hazards

• Ground Rules for an Appeals Conference

– Exam may make oral presentation.

– Appeals may question Exam on specific adjustments. – Appeals may request supplemental information

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IRS Appeals Concerns

• Appeals Officers’ Quality, Negotiation Skills,

Objectivity & Independence Vary.

• Influence of Appeals Economists.

• Slower Traditional Appeals Process.

• Threats to Independence:

– Increasing number of “Emerging” and “Coordinated” Issues.

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Emerging & Coordinated Issues

• Emerging Issue = Issue Being Studied by National

Office for Formal Guidance.

– Appeals settlement subject to oversight.

• Coordinated Issue = Issue Subject to LMSB or

Appeals Coordination.

– Appeals settlement subject to Appeals Coordinated Issue Coordinator’s (“CIC”) approval.

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Tier I Issue – Issues of High Strategic

Importance

• Nonqualified Deferred Executive Compensation §

409A

• Research & Experimentation (“R&E”) Credit Claims

• Transfer of Intangibles Offshore/Cost Sharing

• Tax Shelter – Distressed Asset/Debt

• Tax Shelter – Redemption Bogus Optional Basis

• Listed Abusive Tax Shelters and Transactions

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Tier II Issues – Issues of Significant

Compliance Risk

• Tier II issues are those involving areas of potential

high non-compliance and/or significant compliance

risk or an Industry.

• Tier II issues includes emerging issues a

clarification, direction and guidance.

• Tier II issues require coordination with the Issue

Owner Executive.

• Selected Tier II issues include:

– Casualty Loss: Single Identifiable Property/Capital vs. Repairs

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Tier II Issues – Issues of Significant

Compliance Risk (cont.)

– Cost-Sharing-Stock Based Compensation

– Extraterritorial Income Exclusion Effective Date and Transition Rules

• Accounting Issues: Contractual Allowance

– Non-Performing Loans

– Specified Liability Losses, IRC 172(f) – Super Completed Contract Method

– Upfront Fees, Milestone Payments & Royalties in the Biotech & Pharmaceutical Industries

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Post Appeals Arbitration

• Arbitration ≠ Mediation.

• Available Only For Unagreed Factual Issues.

• Arbitration Conducted Before Mutually Agreed

Appeals or Independent Arbitrator.

• Arbitration May Involve Evidentiary Hearing (and

Presumably IRS Counsel).

• Arbitration Results in Binding Determination

(discretionary or baseball style award).

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Post Appeals Mediation (PAM)

• PAM Represents Third Bite At Appeals Settlement.

• PAM Available at Taxpayer’s Request if Settlement

Negotiations Fail to Resolve Issue.

– Current Appeals practice is to acquiesce to Taxpayer’s PAM request.

• PAM Envisions Two Professionally Trained Mediators

Overseeing Nonbinding Settlement Mediation Between

Taxpayer and Appeals Officer.

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Litigation – Tax Court or Federal Courts

• Multi-Year Marathon

– Pleadings.

– Discovery (i.e. Document production, Interrogatories, Depositions)

– Pretrial Motions. – Stipulations.

– Trial.

– Briefing.

• Substantial Majority of Docketed Cases Settle

Before Trial

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Fast-Track Settlement (“FTS”)

• Tool for Resolving Cases during Audit – IRS Audit

Team retains jurisdiction.

• Taxpayer can file Protest with Appeals if FTS is not

successful.

• Background – Rev. Proc. 2003-40

• FTS = Mediation/Compromise.

• 80%-85% FTS Settlement Rate.

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Early Referral Procedure (ERP)

• Allows Taxpayer to Accelerate Appeals

Consideration of Unagreed Adjustment During

Audit.

– Requires Exam’s issuance of NOPA.

– Requires Exam’s and Appeals’ concurrence.

• Normal Appeals Rules Apply.

– No ex parte communications. – Written brief required.

• If Audit Concludes While ERP Issue Still Under

Appeals Discussion, Case Converts to Normal

Appeals Case.

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U.S. Competent Authority (“USCA”)

Double Tax Cases

• Treaty Procedure Allows Taxpayer, USCA and

Foreign Competent Authority to Agree On Arm's

Length Price For U.S. & Foreign Tax Purposes. See

Rev. Proc. 2006-54.

• Based upon Mutual Assistance Provisions (“MAP”)

of US Treaties.

• MAP is government-to-government (“G-to-G”)

negotiation.

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• Attorney-client privilege.

• Work product doctrine.

• Listed transactions.

• FIN 48 – What is an “uncertain tax position” and

“more likely than not” Standard.

– Transfer Pricing is based on a lesser “reasonableness” standard

– Auditors require a more detailed review

• Textron – What it means and does not mean to

privileged communications.

– See also Regions Financial Corp. & Subs. v. U.S.

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Mutual Agreement Procedure

• Pursuant to Article 25 OECD Model

Convention

• Agreement between tax authorities

• Aim: avoidance of double taxation

• OECD February 2007 Report on improving

resolution of tax treaty disputes

• Arbitration paragraph inclusion in Article 25 OECD

Model Convention

• New MAP Decree Netherlands committing to

arbitration and 2-years to resolve disputes

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Arbitration

• Pursuant to Article 25 OECD Model Convention; or

• Pursuant to EU Arbitration Convention

• Agreement between tax authorities

• Based on arbitration decision

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• For transfer pricing issues only

• Filing of MAP request must be within 3 years

• Advisory Commission to be implemented in case no resolution of MAP within 2 years

• Task of Advisory Commission is to issue opinion on elimination of double tax within 6 months

• Competent authorities must decide within 6 months thereafter, if they fail to reach a decision, the Advisory Commission decision becomes binding

• Great sensitivity regarding 2-year term to go to Advisory Commission:

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– Extension if case is also submitted to court – Waiver by agreement with taxpayer

– Serious penalty exclusion – Triangular cases discussion

• Advisory Commission members:

– One chairman

– Two (or one) representative(s) of each Competent Authority

– Even number of (two) independent persons of standing (nationals and resident of Contracting State)

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• Procedure by which taxpayer and tax authority agree upon correct transfer price for a specific transaction

– If unilateral, pursuant to domestic revenue procedures or decrees

– If bilateral or multilateral, pursuant to Article 25 OECD Model Convention

• Agreement on facts, transfer price and pricing method • Goal: avoidance of adjustments and double taxation

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Key Features APAs

• Tool to obtain tax certainty in advance

• Potential tool to (assist) settle back years/audit disputes and minimize penalty exposure

• Process requires providing upfront information/disclosure and thus exposure. If bilateral: potentially increased

exposure/exchange of information aspects

• Important to manage information flow and process well • Usually entered into for 3-5 years, and as such great way

to get certainty

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Key Features APAs (cont.)

• If unilateral: audit simplification/reduced likelihood of domestic adjustments

• Often greater flexibility: i.e. possibility to include VAT/Customs issues

• Sometimes time-consuming process and unexpected demands (inclusion of more issues than preferred)

• If unilateral, character of ultimate agreement with taxpayer is (usually) a (binding) determination agreement or ruling • If bilateral, character of ultimate agreement with taxpayer

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• Audit Process

– Select Target Companies and Form Audit Teams

– Issue Advance Tax Audit Notice (10 Days before the Audit begins)

– Tax Audit Period (4 to 6 weeks, subject to extension) – Issue Preliminary Tax Assessment Notice

– Issue Tax Assessment Notice

• Strategic Considerations for Taxpayers

– Pre-audit Exercise

– Dealing with the Field Audit Process – Pre- Assessment Review Procedure – Mutual Agreement Procedure

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– Administrative Appeal Procedure through the National Tax Tribunal (“NTT”), etc.

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27 National Tax Service

(Request for examination)

Board of Audit & Inspection

(Request for examination)

Regional Tax Office

(Appeal)

National Tax Tribunal

(Request for adjudication)

Taxpayer (*) Competent Court (**) (**) (**) (**) (**)

*Pre-assessment review procedures can be made within 30 days ** Within 90 days

High Court Supreme Court

Within 14 days Within 14 days (**)

(**)

( **)

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• Mutual Agreement Procedure (MAP)

– Where a result of a tax dispute between the Korean tax authorities and a taxpayer is expected to have impact on the tax authorities of another country with which Korea has an income tax treaty

• Competent Authority Process in the MAPs

– Exchange position paper – Negotiate face to face

– Treaty analyst discusses MAP/APA cases – Exchange closing MAP letters

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others (cont.)

• Korea-US MAP program

– On-going since the 1990s

– General issues: pricing, character, source, PE

• Administrative Appeal Procedure

– Appeal through the National Tax Service (“NTS”), the NTT, or the Board of Audit and Inspection (“BOAI”) – A taxpayer may resort to the judicial review only after

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others (cont.)

•

Judicial Review Procedure

– Appeal through the court system in Korea:

1. The Administrative Court or Competent District Court if outside of Seoul (1year and a half)

2. The High Court (6 months to 1 year)

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and others

• APA Process

– Pre-filing conference

– Submit the APA Application ( NTS International Cooperation Division)

– APA Review (Active participation by the taxpayer and its tax agent strongly recommended)

– Proceed with the MAP (if bilateral) – APA Procedure and Effect

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and others (cont.)

• APA trend in Korea

 APA Applications/ APA’s Concluded/ Applications Pending : Increasing trend

5/7/25 (2003) → 10/16/31 (2004) → 7/25/49 (2005) → 24/24/49 (2006) → 26/32/61 (2007)

 APA Processing Time :

- Unilateral APA : 21 months on the average to 20 months in 2007 - Bilateral APA : 33 months on the average to 17 months in 2007

 Categories of the APAs concluded: Tangible Asset, Service, Intangible Asset and Financial Service (listed in the order of frequency)

- Tangible assets accounted for 60% of the total

 Term of the APAs concluded : 3 to 6 years, but mostly 5 years  Taxpayer’s Home Country (Out of 61 Pending Cases as of end of

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and others (cont.)

• Experience with US (2002~2007)

– Between 15 and 20 completed cases – Roughly half involve US parents

– Approximately 20 pending cases

– Wide variety of covered transactions, but mostly

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Tax Disputes in Mexico

• The Audit Process

– SAT requires the external auditor to submit the transfer pricing study and support for amounts in related-party transactions

– Order forwarded to taxpayer

– Taxpayer is notified of deficiencies found

– Taxpayer responds within following two months (additional one-month extension available) to offer support that its determination is correct

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0

10

20

30

40

50

60

70

80 2004 2005 2006 2007 2008

A u d its 35 2004 – June 2008

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Tax Court Circuit Courts Supreme Competent Authority Tax Court Administrative Appeal Injunction MAP APA Payment Alternatives

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Dispute Resolution – Audit – Mexico

• Setoffs

– They may be accepted in the course of an audit, in practice SAT do not accept them.

• Defenses against penalties:

– Show that you have been diligent in the preparation of the TP Study.

– Show that the Regulations prevented you from using a better method

• Application of the rules to the facts in the case study

– Technical discussion about the legal utilization of the secret comparables

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Dispute Resolution – Audit – Mexico (cont.)

– Headquarters Services expenses will not be subject to

negotiation, if those correspond to a shareholder activity, it would not justify a charge to the recipient companies or those services are duplicate with the Mexican Company

• The SAT is flexible for the Arm’s Length resolution, base on a technical criteria

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• Administrative Appeal

– Involves filing a protest before the Appeals Office (the Central Tax Counsel) in the SAT, with arguments of form and/or substance. The term to file the appeal is 45

business days

• Action Before the Tax Court

– The taxpayer files a petition before the Tax Court (the

Federal Court for Tax and Administrative Justice). The suit must be filed within 45 business days

• Competent Authority Procedure

– This procedure involves exercising the right provided in the treaties to avoid double taxation, entered into between

Mexico and the countries of residence of related parties with whom the transactions giving rise to the Notice of

Deficiency were carried on, to invoke the mechanism for negotiations between or among the tax authorities of the countries involved.

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Competent Authority – Mexico

• Goal: Avoidance of Double Taxation

• SAT have some experience with Japan, USA &

Canada

• Limit on time for beginning competent authority

proceedings

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• Article 217 MITL. This procedure involves exercising the right provided in the treaties to avoid double taxation

• No surcharges or interest under this procedure • Primary allocations

– Here, reduction of deduction for cost of raw materials

(assuming gross margin of 22 percent) equal to 8% of $500, or $40, results in additional income tax in Mexico

• Additional Consequences

– Characterization issue of the excess amount paid to USCorp – If earnings of MexicoCo have been fully distributed,

additional gross up would be required.

• Avoidance of Additional Consequences

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APAs – Mexico

• Types of Advance Pricing Resolutions

– Unilateral: more than 1400 – Bilateral: more than 120 – Multilateral

• APR Team

• Time to complete

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Marc Levey, New York, B&M Monique van Herksen, Amsterdam, B&M Moises Curiel-Garcia, Mexico City, B&M Sai Ree Yun, Korea, Yulchon

2009 Asia Pacific Transfer Pricing Conference