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A comparative analysis of the major areas of tax controversy in developed countries
A Comparative Analysis of the Major Areas of Tax Controversy in Developed Countries
Walter
F. O’Connor
l&s paper responds to the growing inquiry into what areas of tax controversy are emerging as the most important to taxpayers and the tax administrations in major developed countries around the world. The study arises because of the globalization of the world economy and the issues arising with regard to tax administrations’ability to deal with the areas of taxation from international business activities. The paper identifie the most important tax issues presently facing taxpayers and tax administrators in Australia, Brazil, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, and the United Kingdom. i%e study utilized the experiences of the major international accounting firms, and in particular, the professionals in those firms who deal with large multinational corporations doing business in their country and abroad. The principal findings of the study are that the areas of tax controversy in the countries studied are significantly dfferentfrom thosefound in the United States. This is due to (1) the role that income tax plays in those countries versus other taxes, (2) the relationship that the tax adviser has with the taxpayer, and (3) the relationship that the taxpayer/tax adviser has with the tax administration in the countries studied.
The economies of the world are becoming more integrated, as the movements of goods and services across national boundaries are facilitated through technological advances. The role of telecommunications in enabling information to cross borders more rapidly is an illustration of how not only physical products move more efficiently across borders, but also how the transfer of personal services has become more mobile. Indeed, telecommunications is credited with the role of making labor more exportable, not in terms of moving physical bodies across borders, but in making the shifting of their valuable intellect mobile. Given this phenomenon, the concept of comparative advantage is not just manifesting itself on a nation state basis, but also on an international basis. Journal
of International
Copyright Walter
F. O’Connor
Fordham
Accounting
@ 1992 by JAI Press, Inc.
University,
l
Auditing
& Taxation,
I( 1):61-79
All rights of reproduction
ISSN:
1061-9518
in any form reserved.
Department of Accounting, Graduate School of Business Administration, 113 West 60th Street, New York, NY 10023.
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Multinational corporations today routinely source the production of their components and serve the markets of other countries by establishing facilities in many parts of the world. M.H. Hoeflick (1983) indicates the philosophy that a multinational corporation is “based” in one country is becoming a vanishing phenomenon. This has even manifested itself in the situation of the United States where, traditionally, a company incorporated in the United States was seen as being a corporation based in the United States (Kirkwood and Muller, 1984). Multinational corporations have already served notice to the U.S. Congress that, because of the international competition they face, they cannot see themselves giving an advantage to U.S. plants for production purposes if locating those plants abroad will be required to make them more competitive. This business reality has international tax ramifications. “International” no longer means a Delaware corporation with subsidiaries in Germany, Brazil, and Japan serving the local markets. It consists of a company incorporated anywhere in the world trying to manufacture its products and generate its services in those countries that will provide these functions most economically, and utilize those products and services to penetrate consumer markets in other parts of the world. As a result, the need for sophisticated knowledge of tax rules exists for companies incorporated in the United States, but also for companies that see themselves as nation-less. This requires they have confidence in facing complicated tax issues in all major countries in the world. The need to comply with the tax laws in those countries is essential. Also essential now is the need to understand the major sources of tax revenues and the sophistication of the tax administrations, if the multinational company wishes to become profitable on a long term basis (Dubin, Graetz, and Wilde, 1990). A corollary to this development is the fact that the tax administrators in various countries can no longer view their role as dealing solely with companies founded in their country and doing business in their country. As Wright (1984) indicates, they must also deal with the more complicated issues of companies doing business with their countries without necessarily having establishments in their countries. This puts a burden on tax administrators to see that they raise the appropriate amount of revenue from multinational corporations that, through telecommunications and other technological advances, are making economic penetration of those countries, but in less tangible ways than the tax administration was used to facing in the past (Price, 1990). A third party in this scenario is the tax adviser. This person serves the taxpayer on a global basis. They must plan to achieve the results of the lowest possible tax burden, while at the same time realizing that the tax administrations of the world are becoming more sophisticated, not just with regard to national tax issues, but also international tax issues. Finally, globalization of the economy is not only having an impact on tax administrations from the standpoint of cross-border transactions, (e.g., transfer pricing, cross-border licensing, cross-border leasing of tangible property, cross-
Analysis of Tax Controversy in Developed Countries
63
border technology service agreements, and sophisticated financial packages) but also from the growing sophistication of the tax issues that arise within the national borders. As M.H. Hoeflick (1983) illustrates, more sophisticated issues dealing with inventories, tax depreciation, foreign currency transactions, and sophisticated debt/ equity issues are becoming of increasing importance. Overriding all these areas is the fact that access to greater amounts of information dealing with tax issues is required by taxpayers, their advisers, and the tax administrations. It is no longer satisfactory just to have information about what is going on within a particular nation. As Merritt (1984) demonstrates, it is important to have information on what is occurring outside the country to determine the tax impact on the country itself. This is necessary because many multinational corporations are doing business with a foreign country without necessarily being engaged in business in the foreign country. For example, it is now commonplace for a foreign corporation having branch operations in the United States to have requests from the U.S. Internal Revenue Service to make visits to the head office to verify expenses incurred outside the United States. These expenses are relevant in determining the taxable income of the foreign company in the United States. Given this interrelationship of national economies with those of other countries and the burdens it produces for tax administrators in individual countries, one might anticipate that there is a significant amount of collaboration by tax administrators around the world. Parisius (1990) provides support for the view that, although there are provisions in tax treaties between countries for mutual assistance, essentially these pertain only to transactions that involve cross-border issues. That is, if a German company is selling products to a French corporation and disagreements arise between the tax administration in Germany and the tax administration of France, there are circumstances by which the German company can seek relief through the tax treaty competent authority mechanism between Germany and France so that it is not subjected to double taxation. However, in the every day life of a German tax administrator facing sophisticated tax issues, that administrator must rely primarily on his or her own ingenuity in determining what tax issues might be raised to secure the revenue for Germany. This would apply not only in situations with a German-owned German company, but also a German company that might be subsidiary of a U.S. corporation (Hoeflick, 1983).
JUSTIFICATIONFORTHE
STUDY
The tax literature was searched to ascertain what research has been done in the area of identifying the major tax issues facing taxpayers in developed countries. Where research has been done, it essentially has been anecdotal in nature and has appeared primarily in the professional journals (Newman and
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Burton, 1986). For this reason-a research project was undertaken to identify the major tax controversies between taxpayers and tax administrations with developed countries around the world with the goal of ranking the frequency with which they occur. The motivation for this study was based on the difficulty that excess foreign tax credits are creating for U.S. based multinational companies (Muller, 1990). Those familiar with international business know that the U.S. tax system permits U.S. taxpayers to offset foreign income taxes against their U.S. income tax liability, subject to certain limitations. Such limitations are basically structured so that foreign taxes may not offset U.S. taxes, if they exceed the U.S. tax on foreign source income. Since the U.S. Tax Reform Act of 1986 reduced U.S. tax rates, excess of foreign taxes over U.S. taxes have become a reality. As Bowman (1984) explains, added to this problem is the fact that tax examinations in foreign countries have become more sophisticated. The result is that foreign tax audits have increasingly contributed to the excess foreign tax credit problem of U.S. based multinationals (Millman and Harpo, 1984).
METHOD
To secure the information necessary to perform this research, the author engaged three international accounting firms (Arthur Andersen and Co., S.C., KPMG Peat Marwick, and Price Waterhouse) and secured from the senior international tax partners of those firms an agreement to utilize a research questionnaire to be circulated to a representative grouping of tax people in the countries selected. The respondents were experienced with the Internal Revenue Service, since they have worked with the U.S. offices of their firm on international tax issues raised by the IRS. The questionnaire that was initially developed was pilot tested with representatives of the three international accounting firms in the following countries: Australia Brazil Canada France Germany Italy Japan The Netherlands Sweden The United Kingdom
Analysis of Tax Controversy
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65
Countries
TABLE 1. Survey Responses Australia Brazil Canada France Germany Italy Japan The Netherlands Sweden The United Kingdom Total
41 27 52 39 56 29 41 42 32 41 412
These countries raise most of the major tax issues facing U.S. based multinational companies. The final questionnaire was distributed to taxpayers, tax administrators, and tax advisory professionals in the countries indicated to secure their opinions as to which tax issues are the most important in the administration of the tax practice in each country. One thousand questionnaires were distributed, and 412 replies were received. The responses from each country can be found in Table 1. Based on the replies received, a first tabulation was made by subject to produce the most important issues in the aggregate. A second tabulation was made of the responses by individual countries to determine the most important issues in each country. These tabulations can be found in Table 2. RESULTS IN AGGREGATE The Most Important
Tax Issues in Developed
Countries
1. Transfer Pricing. The most important subject matter dealing with international examinations by tax authorities is that involving transfer pricing. That is, tax authorities look most closely at pricing to companies in their countries and also pricing by companies from their countries where the transaction involves two related parties. For U.S. tax purposes, this would be considered the Section 482 issue whereby related parties are required to deal with each other on an arms length basis in conducting the buying and selling of inventory in their normal trade or business. From this, one can infer that transfer pricing has been used by taxpayers as a major technique for shifting profits from one country to another.
Transfer Pricing Capital vs. Ordinary Expenses Travel and Entertainment Expenses Tax Depreciation Employee Benefits as Income Management Charges Accrual of Expenses Debt vs. Equity Multiple Taxpayers Penalties Collection Issues Inflation Issues Incentives Rule Making Procedures Recording of Transactions 10 6 9 7
3 4 5 6 7 9 10 3 5
4
1 8
Aus
1 2
Aggregate
3 1 2 4
10
7 9 8
6 5
Bra
2
6 8 9 7 5 10
3 4
Can
9 8 10 2 3 6 -
1 5
Fra
9 6 4 3 7 1 10
2 5
Ger
1
8 2 4 7 10 5
6 3
Ita
TABLE 2. Summary Rankings of Important Tax Issues
6
1 4 8 5 9 IO
3 2
Jap
6 5 8 10 1 2 10
3 4
Neth
4 8 5 9 2 10 1
3 6
Swe
6 2 9 7 8 4 10
3 1
UK
2
3 FY
z 7
z
z
g
b
c
$
5
g
z 2
AnaIysis of Tax Controversy
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One must keep in mind that the respondents to the questionnaire are conditioned by an environment in which the United States tax rates were higher than the foreign tax rates. Consequently, U.S. companies would normally be the ones involved in shifting profits to foreign countries. However, with declining U.S. tax rates and the stabilization or increase of foreign tax rates, the study suggests that foreign countries are becoming more sensitive to the fact that U.S. companies may want to shift profits from those foreign countries to the United States, in order to enjoy the lower U.S. tax rates. As a result, further research may be required to determine whether this trend will continue, as more experience is gained with the 1986 and 1990 tax legislation in the United States and the decreasing of U.S. tax rates relative to other developed countries. 2. Capital vs. Ordinary Expenses. The second issue is one purely domestic to most countries. It involves the attempt by corporations to take as a tax deduction expenditures that may be considered capital in nature, and therefore, should be capitalized and written off over future years. The issue involved here is more a question of the shifting of income from current years into future years by the deferral of taxable income to those late years. This foreign country issue is not surprising, since this is also a major one in the United States. That is, what constitutes a deductible expense versus what constitutes a capital expenditure is equally important worldwide. 3. Deducting Personal Expenses. The third most critical issue for tax examinations is the extent to which taxpayers are taking personal expenditures as tax deductible business expenses. In certain cases, the U.S. restricts the amount of an entertainment deduction to eighty percent of the expenditure placing a percentage limitation on the deductibility of that amount. In other countries, such as Japan, there is an absolute limitation on the deductibility of such items. This type of expenditure is very often associated with small businesses or closely held companies. Consequently, it is interesting that it has reached such a high priority position. Further research will be necessary to determine the extent to which this issue gives rise to penalties assessed by the tax authorities on taxpayers who seek to deduct items of a personal nature as tax deductible business expenses. 4. Tax Depreciation. Tax depreciation is also primarily a domestic and not an international issue. This matter has been extremely important in the U.S. Internal Revenue Code with issues dealing with what are depreciable assets, what depreciation methods are applicable, and the length of depreciation lives. The results indicated the same constraints apply to foreign countries. Taxable entities very often try to treat an expenditure as having a shorter life or being entitled to an accelerated depreciation method. This has implications not only for foreign companies in general but, in particular, subsidiaries of U.S. based
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parent companies. The reason is that it impacts the calculation of the deemed paid foreign tax credit on dividends received by U.S. corporate shareholders from foreign investee corporations. 5. Employee Benefits as Income. It is surprising that this issue ranks so high in terms of the areas foreign tax authorities delve into on the tax filings of foreign taxpayers. Foreign companies are often entitled to a tax deduction for the item as a trade or business expense, while the employees may not have to report this as gross income. This has implications with regard to employee relations, since the utilization of company property and company facilities for personal purposes is an important form of “de facto” income for employees in many countries. Japan is an important example where employees have significant expense accounts for the promulgation of company business. This can be considered income to the individuals to the extent they use those expenditures for personal purposes. The same is true in Germany, where the utilization of company automobiles is an important fringe benefit, and in the U.K., where the use of club facilities is important. 6. Management Charges. This issue clearly has international implications. After transfer pricing, this is the tax issue that foreign tax authorities look at most closely in determining the extent to which profits are being shifted from a subsidiary company to a foreign parent company that imposes charges for management services rendered for the subsidiary. The foreign countries in this study indicated substantial amounts of income flowed to U.S. parent companies through the use of management charges. This is logical, since such charges will often not require the withholding of foreign taxes on these payments. The technique by which these charges are imposed on the subsidiaries also can be a factor. If it is done in the form of invoices for odd amounts, it may not be scrutinized very closely by foreign tax authorities. 7. Accrual of Expenses. This is a very broad category of domestic tax controversy importance, since foreign companies may very likely be claiming tax deductions for the accrual of expense by setting up reserves when the liability of the corporation has not yet been fully determined. This has accounting as well as tax significance, because there is a significant amount of authority in the accounting literature for accruing such expenses. In some countries, such as Germany, a deduction is not permitted for tax purposes unless it is recorded for accounting purposes. Therefore, to the extent a company tends to over accrue expenses could mean the gaining of tax deductions at an earlier stage. Since the item in question would presumably be deductible at some future point, the major factor here is shifting of profits from current years to future years and capitalizing on the time value of money.
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It may seem surprising that this 8. Capital Gains vs. Ordinary Income. issue ranks relatively low, since many countries give a special rate of taxation on capital gains (sometimes zero as in the case of Australia). Proving that an item is capital in nature might very likely result in exemption from taxation. More research needs to be done to ascertain the importance of this issue in those countries in which capital gains get special treatment. This is in sharp contrast to the U.S., which, from 1986 to 1991, did not have a differential in the tax rate applied to capital gains vs. ordinary income, running counter to the tax policy in most countries around the world. This issue clearly has domestic as well as international 9. Debt vs. Equity. implications, since interest is normally deductible in most countries and dividends are not. It should be noted that in countries where the integrated system of taxation is generally applicable, there is a lower tax rate on distributed income. A clear example of this would be Germany, where the tax rate has varied from thirty-four percent to fifty percent by being distributed as opposed to retained. This is true regardless of.whether the recipient of the dividends is a foreign or domestic company. In the international environment, it is even more important, since U.S. parent corporations have used a technique of bringing profits out of a subsidiary company by having a very high debt to equity ratio at the subsidiary level. Specific special tax rules on this subject are covered in the tax laws of France, Germany, and Japan. It is also important where U.S. subsidiaries of foreign corporations are involved. This is because, until recently, the payment of interest was very likely deductible in the U.S., and not subject to U.S. withholding tax. This results from tax treaties that the U.S. has signed with many countries exempting interest payments from U.S. taxation. 10. Multiple Taxpayers. Multiple taxpayers is clearly a domestic issue, although it has international implications. A number of years ago, the United States eliminated the ability of U.S. businesses to proliferate subsidiaries to take advantage of lower tax rates applicable to smaller amounts of corporate income. The tax planning opportunity is still available in some countries, however, and is being utilized so that income attributable to subsidiaries does not get taxed to the parent company. Unless foreign tax examiners are successful in their challenge, the spreading of large amounts of income via a multiplicity of subsidiaries will enable companies to greatly minimize their tax liabilities. RESULTSBY
COUNTRY Australia
For Australia, the three most important issues for tax examinations are transfer pricing, employee benefits, and penalties. This is the first time that the
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results indicated penalties as a major factor in the areas challenged by foreign tax authorities. In the U.S., penalties have become extremely important in the enforcement process. Where taxpayers take a tax deduction to which they are not entitled, or do not report income that they have earned, the penalty weapon challenges taxpayers who take tax positions in a frivolous manner. This is a new phenomenon in the U.S. and, yet, seems to have developed at an early stage in Australia. Brazil For Brazil, a number of subjects were equally weighted with regard to areas of major consequence to tax authorities. A new item not mentioned in the general observations deals with the inflation implications. This is because Brazil is a hyper-inflationary environment. As a result, significant amounts of taxes can be saved by revaluing assets and taking tax depreciation on the new valuation. Since the revaluation does not give rise to taxable income immediately, there are significant savings to the taxpayers. Indeed, many of the items listed from Brazil do not arise in connection with the major areas for examination in other countries. As a result, Brazil is somewhat unique in terms of the tax examinations issues which arise. Canada For Canada, the most important item is that of distinguishing between capital gains and ordinary income. This is because capital gains are non-taxable in Canada. Consequently, a victory by the taxpayer in treating an item as a capital gain versus ordinary income is total exemption from taxation. It is, therefore, not surprising to see that the tax authorities in Canada put a very high priority on examining these items in their evaluation of the results of taxpayers in that country. Tax incentives are also an important issue in Canada for purposes of tax examinations, since they provide the opportunity for taxpayers to avoid taxation completely. A third area of importance in Canada is transfer pricing. This is also not surprising, given the geographical proximity between the United States companies and their subsidiaries in Canada and the volume of commerce that results. France A wide variety of issues of contention exists between the tax authorities and taxpayers in France. Transfer pricing and management charges, however, are the two most important areas of controversy. These apply particu!arly to international transactions, since these two items have been used in recent years by U.S. parents with French subsidiaries to shift profits from France to the United States.
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Transfer pricing is of high concern in Germany. The extremely high tax rate in Germany (fifty percent) compared with that in the U.S. (thirty-four percent in current years) makes this issue expected. Clearly, German tax authorities are particularly sensitive to the difference in tax rates. Thus, they look for all foreign companies, (not just those from the United States) seeking to shift profits out of Germany to avoid their higher tax rates. Other areas of major controversy involving Germany are debt vs. equity issues, management charges into Germany, branch tax issues, employee benefits, and non-taxable transactions. The branch tax issue is important to international banks, since there are many American banks with operations in Germany that seek to reduce their tax liabilities by minimizing branch income. In addition, the constructive dividends issue is important, because Germany imposes a significantly lesser amount of taxation on distributed profits. Moving profits out of Germany means German companies will show a lower amount of overall tax liability. Italy In the case of Italy, one of the most important areas of tax contention deals with accounting requirements. This is different from many other countries. One can glean from this, that there is a close tie between the way in which transactions are recorded for accounting purposes and the way they are treated for tax purposes. The extent that a company does not record an expense for accounting purposes precludes it from getting a deduction for tax purposes. This would produce a challenge from the Italian tax authorities. The other major issues of tax disagreement in Italy deal with tax depreciation, capital vs. ordinary expense determination, and travel and entertainment expenses. All of these fall into those categories seen more commonly in other countries. Japan The areas of greatest disagreement between taxpayers and the tax authorities in Japan deal with travel and entertainment expenses and capital vs. ordinary expenditures. Entertainment expenses are not deductible for all practical purposes in Japan. Therefore, if an expenditure is so categorized, the tax authorities in Japan have an opportunity of raising significantly greater amounts of revenue. Similarly, since capital expenditures are generally not deductible in Japan, a determination that an item is capital in nature provides the tax authorities with a motive for investigation. From an international standpoint, the third area of major importance for tax examination in Japan deals with transfer pricing. The interesting element here is that it does not relate to transfer pricing between a U.S. parent and a Japanese subsidiary, but rather
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between a Japanese parent and U.S. subsidiaries. in the public record dealing with the Toyota automobiles to the United States.
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Reference to this was made Motor Company sales of
Netherlands The responses from the Netherlands provided a significant listing of areas of examination by Dutch tax authorities, all having somewhat equal weighting. First seen in the study at a highly weighted level is the deductibility of personal expenses on individual tax returns. This is a domestic tax issue of high importance in the Netherlands. On the corporate side, an area of equal importance deals with the determination of debt vs. equity. This is because interest expenses are deductible, whereas dividends are not. The debt vs. equity issue as well as transfer pricing tax controversies have international implications of importance to the Dutch tax authorities. Also important in the Netherlands is the determination of whether an expenditure is capital or ordinary in nature.
Sweden For Sweden, the results indicated that the utilization of multiple taxpayers and the accrual of expenses are the two most important areas of contention between the Swedish tax authorities and taxpayers. Given the very high tax rates in Sweden, tax planning involves the proliferation of companies in the corporate groups, giving the opportunity to lower the tax rate by using the lower brackets of taxation for corporations. In addition, when an expense is not properly accrued in Sweden, it also presents an area of contention due to the time value of money implication.
United Kingdom For the United Kingdom, one of the major areas of controversy between Inland Revenue and taxpayers is the issue of capital vs. ordinary expenditures. In addition, capital cost allowances (tax depreciation) is important in the United Kingdom. Both of these items deal with the determination of what can be written off immediately vs. what must be capitalized and either not deducted at all or deducted over a period of time in the future. In addition, from the standpoint of international issues, debt vs. equity and transfer pricing are areas of high importance. Given the fact that there is a significant amount of commercial intercourse between the United States and the United Kingdom, it is not surprising that tax authorities from both nations are now examining these issues with close scrutiny.
Analysis of Tax Controversy
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CONCLUSIONS This study has been able to identify those tax issues that are receiving the greatest attention of tax authorities in ten major developed countries of the world other than the United States. It has ranked those areas of tax controversy so that one can see, in descending order, where most controversy exists between the taxpayers and the tax administration. Furthermore, from this study, one can determine which areas are mostly focused on international versus domestic issues. This research has sought to break ground in an area in which much of the information to date has been anecdotal in nature. The study attempted to identify the major issues emerging from the growing sophistication of tax controversies with tax authorities around the world. The U.S. Internal Revenue Service has the reputation, on a global basis, of being the most aggressive (and perhaps the most knowledgeable) tax authority from the standpoint of challenging taxpayers. Just as the sophistication of the developed countries around the world has grown in commercial terms, the sophistication in dealing with tax matters has also grown. Given the globalization of world economies, the international tax implications of this study should be expanded from the standpoint of the extent to which capital is moving from some countries to other parts of the world. The current study focused to some extent on international tax transactions that involve U.S. based companies going to other countries. On the other hand, the developments of the 1980s and presumably the 199Os, will give rise to tax issues that will be raised by the significant amount of inbound investment into the United States. The Europe 1992 phenomenon alone will provide this. The United States has now become a relatively low tax rate country. Consequently, the past inclination of U.S. companies to shift profits abroad is probably being reversed with U.S. companies seeking to avoid excess foreign tax credits. The extent to which the countries represented in this survey will adopt policies by tax authorities to prevent the shifting of profits back to the U.S. should be explored. APPENDIX Survey of Major Issues Being Raised with Corporate Taxpayers by Tax Authorities in Selected Foreign Countries
This questionnaire is part of a study designed in conjunction with international accounting firms to learn more about major issues being raised by tax authorities in selected foreign countries with corporate taxpayers.
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The importance of this project is in large part attributable to the recent globalization of the economies of the world. Since little empirical work has been done in this area to date, the results of this study should prove relevant to all readers. The completed questionnaires are processed by automated equipment which summarizes the answers in statistical form so that individual respondents cannot be identified. The individual responses to the questionnaire will remain confidential. We thank you for your participation and look forward to supplying you with the results of our research.
1.
Does the country in which your tax activity is located have the equivalent of the United States Internal Service - i.e., a tax authority which audits tax returns for compliance with the tax laws? 1.
2.
YES
1 1
2.
NO[
1
If your answer to question #1 is yes, what is the title of that tax authority?
If your answer to #I is no, go to question #7. 3.
How would you rate the degree of similarity between the taxpayer and tax authority referred to in question I, and the taxpayer and the IRS with respect to the following dimensions.
Identical A.
B.
Independence of tax authority from taxpayer in relation to: 1. Rule-making 2. Collection 3. Enforcement Voluntary disclosure versus nonvoluntary disclosure on the part of the taxpayer.
t
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t
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Analysis of Tax Controversy 4.
A. B.
in Developed
75
Countries
Please list the key factors in your country that are the tax issues of importance. Please prioritize these factors in descending order (i.e., 1 = highest; 10 = lowest). RATING
FACTORS 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 5.
Most Important
Very Important
Important
[ 1 [ 1
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1
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1 1 [ 1
[ I [ 1
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Least Important
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1
From the factors listed above, evaluate the first five key factors and rate them with respect to the following criteria as highest priority determinants of the ranking in question #4.
Least Occasionally Most Very Factor #l Important Important Important Important Important a. Frequency i.e., how often does this issue arise in an examination of a taxpayer in your country? [
b.
1
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[ of money
1
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to this
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C.
Political, Economic Environment i.e., to what extent does this factor affect lawmaking, financial reporting, etc.?
d.
Industry Related i.e., does this type of disagreement arise more often within a particular industry such as banking, insurance, etc.?
e.
Other. Please specify.
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Factor #2 Frequency a. b. Dollar value Political, C. Economic Environment d. Industry Related e. Other. Please Specify.
Factor #3 a. b. C.
d.
e.
Frequency Dollar value Political, Economic Environment Industry Related Other. Please Specify.
Factor #4 Frequency a. b. Dollar value Political, C. Economic Environment d. Industry Related
Most Important
ACCOUNTING
Very Important
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Important
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Analysis of Tax Controversy in Developed
e.
Other. Please Specify.
Factor #5 a. Frequency b. Dollar value Political, C. Economic Environment d. Industry Related e. Other. Please Specify.
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Most Important Frequency Dollar value Political, Economic Environment Industry Related Other. Please Specify.
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All 5 factors considered
a. b.
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71
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Least Important
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The following is a list of variables that have been cited as important issues of conflict between the IRS and taxpayers in the United States. How would you rank these factors in your country?
INTERNATIONAL
78
FACTOR 1. Tax depreciation 2. Capital versus ordinary expenditure 3. Debt versus equity (Interest versus dividends) 4. Financing of receivables 5. Travel & Entertainment Expenditures 6. Lease versus purchase of assets 7. Executive compensation & retirement allowances 8. Cross Border Transactions 9. Mergers & Acquisitions 10. Tax Shelter Investment
7.
Most Important
ACCOUNTING
Very Important
1992
AUDITING
& TAXATION,
l(1)
Important
Occasionally Important
Irrelevant
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Please describe what method, if any, is employed ensure that taxpayers comply with tax laws.
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by your government
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Analysis of Tax Controversy
in Developed
Countries
79
REFERENCES Bowman, John W. 1984. “IRS Procedures-Getting Through the Maze,” Journal of Accountancy, 158 (October): 93-108. Dubin, Jeffrey A., Michael A. Graetz, and Louis L. Wilde. 1990. “The Changing Face of Tax Enforcement 1978-1988,” Tax Lawyer, 43 (Summer): 893-914. Gordon, Newman & Burton. 1986. “International Examination Issues,” 77re Tax Executive, Spring: 213-227. Hoeflick, M.H. 1983. “Of Reason, Germanship, and Taxes: A Jurisprudential and Gowes Theoretical Approach to the Problem of Voluntary Compliance,” American Journal of Tax Policy, 2 (Spring): 79-88. Kirkwood, Peter, and Charles Muller. 1984. “Tax Policy and Administration,” Florida Bar Journal, 58 (November): 615-618. Merritt, James E. 1984. “New Procedures Used by the IRS to Attack Tax Shelters,” Tax Section, State Bur of California, 10 (Summer): 6-19. Millman, Stephen L., and Guy J. Harpo, Jr. 1984. “Current Partnership Audit Issues,” New York University 48th Annual Institute on Federal Taxation, pp. 48-l to 48-37. Muller, Robert E. 1990. “The Unagreed Case,” Michigan Bar Journal, 69 (November): 11641169. Parisius, David K. 1990. “Government Tax Investigations and Foreign Secrecy Laws,” International Tax Journal, 16 (Fall): 275302. Price, Charles F. 1990. “IRS Audit and Appeals File Data,” Oil & Gus Tax Quarterly, 39 (September): 75-87. Wright, Deloris R. 1984. “Economics, Intangibles, and Section 482,” International Tux Journal, 10 (March): 223-232.
Walter
F. O’Connor
l&s paper responds to the growing inquiry into what areas of tax controversy are emerging as the most important to taxpayers and the tax administrations in major developed countries around the world. The study arises because of the globalization of the world economy and the issues arising with regard to tax administrations’ability to deal with the areas of taxation from international business activities. The paper identifie the most important tax issues presently facing taxpayers and tax administrators in Australia, Brazil, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, and the United Kingdom. i%e study utilized the experiences of the major international accounting firms, and in particular, the professionals in those firms who deal with large multinational corporations doing business in their country and abroad. The principal findings of the study are that the areas of tax controversy in the countries studied are significantly dfferentfrom thosefound in the United States. This is due to (1) the role that income tax plays in those countries versus other taxes, (2) the relationship that the tax adviser has with the taxpayer, and (3) the relationship that the taxpayer/tax adviser has with the tax administration in the countries studied.
The economies of the world are becoming more integrated, as the movements of goods and services across national boundaries are facilitated through technological advances. The role of telecommunications in enabling information to cross borders more rapidly is an illustration of how not only physical products move more efficiently across borders, but also how the transfer of personal services has become more mobile. Indeed, telecommunications is credited with the role of making labor more exportable, not in terms of moving physical bodies across borders, but in making the shifting of their valuable intellect mobile. Given this phenomenon, the concept of comparative advantage is not just manifesting itself on a nation state basis, but also on an international basis. Journal
of International
Copyright Walter
F. O’Connor
Fordham
Accounting
@ 1992 by JAI Press, Inc.
University,
l
Auditing
& Taxation,
I( 1):61-79
All rights of reproduction
ISSN:
1061-9518
in any form reserved.
Department of Accounting, Graduate School of Business Administration, 113 West 60th Street, New York, NY 10023.
62
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l(1)
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Multinational corporations today routinely source the production of their components and serve the markets of other countries by establishing facilities in many parts of the world. M.H. Hoeflick (1983) indicates the philosophy that a multinational corporation is “based” in one country is becoming a vanishing phenomenon. This has even manifested itself in the situation of the United States where, traditionally, a company incorporated in the United States was seen as being a corporation based in the United States (Kirkwood and Muller, 1984). Multinational corporations have already served notice to the U.S. Congress that, because of the international competition they face, they cannot see themselves giving an advantage to U.S. plants for production purposes if locating those plants abroad will be required to make them more competitive. This business reality has international tax ramifications. “International” no longer means a Delaware corporation with subsidiaries in Germany, Brazil, and Japan serving the local markets. It consists of a company incorporated anywhere in the world trying to manufacture its products and generate its services in those countries that will provide these functions most economically, and utilize those products and services to penetrate consumer markets in other parts of the world. As a result, the need for sophisticated knowledge of tax rules exists for companies incorporated in the United States, but also for companies that see themselves as nation-less. This requires they have confidence in facing complicated tax issues in all major countries in the world. The need to comply with the tax laws in those countries is essential. Also essential now is the need to understand the major sources of tax revenues and the sophistication of the tax administrations, if the multinational company wishes to become profitable on a long term basis (Dubin, Graetz, and Wilde, 1990). A corollary to this development is the fact that the tax administrators in various countries can no longer view their role as dealing solely with companies founded in their country and doing business in their country. As Wright (1984) indicates, they must also deal with the more complicated issues of companies doing business with their countries without necessarily having establishments in their countries. This puts a burden on tax administrators to see that they raise the appropriate amount of revenue from multinational corporations that, through telecommunications and other technological advances, are making economic penetration of those countries, but in less tangible ways than the tax administration was used to facing in the past (Price, 1990). A third party in this scenario is the tax adviser. This person serves the taxpayer on a global basis. They must plan to achieve the results of the lowest possible tax burden, while at the same time realizing that the tax administrations of the world are becoming more sophisticated, not just with regard to national tax issues, but also international tax issues. Finally, globalization of the economy is not only having an impact on tax administrations from the standpoint of cross-border transactions, (e.g., transfer pricing, cross-border licensing, cross-border leasing of tangible property, cross-
Analysis of Tax Controversy in Developed Countries
63
border technology service agreements, and sophisticated financial packages) but also from the growing sophistication of the tax issues that arise within the national borders. As M.H. Hoeflick (1983) illustrates, more sophisticated issues dealing with inventories, tax depreciation, foreign currency transactions, and sophisticated debt/ equity issues are becoming of increasing importance. Overriding all these areas is the fact that access to greater amounts of information dealing with tax issues is required by taxpayers, their advisers, and the tax administrations. It is no longer satisfactory just to have information about what is going on within a particular nation. As Merritt (1984) demonstrates, it is important to have information on what is occurring outside the country to determine the tax impact on the country itself. This is necessary because many multinational corporations are doing business with a foreign country without necessarily being engaged in business in the foreign country. For example, it is now commonplace for a foreign corporation having branch operations in the United States to have requests from the U.S. Internal Revenue Service to make visits to the head office to verify expenses incurred outside the United States. These expenses are relevant in determining the taxable income of the foreign company in the United States. Given this interrelationship of national economies with those of other countries and the burdens it produces for tax administrators in individual countries, one might anticipate that there is a significant amount of collaboration by tax administrators around the world. Parisius (1990) provides support for the view that, although there are provisions in tax treaties between countries for mutual assistance, essentially these pertain only to transactions that involve cross-border issues. That is, if a German company is selling products to a French corporation and disagreements arise between the tax administration in Germany and the tax administration of France, there are circumstances by which the German company can seek relief through the tax treaty competent authority mechanism between Germany and France so that it is not subjected to double taxation. However, in the every day life of a German tax administrator facing sophisticated tax issues, that administrator must rely primarily on his or her own ingenuity in determining what tax issues might be raised to secure the revenue for Germany. This would apply not only in situations with a German-owned German company, but also a German company that might be subsidiary of a U.S. corporation (Hoeflick, 1983).
JUSTIFICATIONFORTHE
STUDY
The tax literature was searched to ascertain what research has been done in the area of identifying the major tax issues facing taxpayers in developed countries. Where research has been done, it essentially has been anecdotal in nature and has appeared primarily in the professional journals (Newman and
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Burton, 1986). For this reason-a research project was undertaken to identify the major tax controversies between taxpayers and tax administrations with developed countries around the world with the goal of ranking the frequency with which they occur. The motivation for this study was based on the difficulty that excess foreign tax credits are creating for U.S. based multinational companies (Muller, 1990). Those familiar with international business know that the U.S. tax system permits U.S. taxpayers to offset foreign income taxes against their U.S. income tax liability, subject to certain limitations. Such limitations are basically structured so that foreign taxes may not offset U.S. taxes, if they exceed the U.S. tax on foreign source income. Since the U.S. Tax Reform Act of 1986 reduced U.S. tax rates, excess of foreign taxes over U.S. taxes have become a reality. As Bowman (1984) explains, added to this problem is the fact that tax examinations in foreign countries have become more sophisticated. The result is that foreign tax audits have increasingly contributed to the excess foreign tax credit problem of U.S. based multinationals (Millman and Harpo, 1984).
METHOD
To secure the information necessary to perform this research, the author engaged three international accounting firms (Arthur Andersen and Co., S.C., KPMG Peat Marwick, and Price Waterhouse) and secured from the senior international tax partners of those firms an agreement to utilize a research questionnaire to be circulated to a representative grouping of tax people in the countries selected. The respondents were experienced with the Internal Revenue Service, since they have worked with the U.S. offices of their firm on international tax issues raised by the IRS. The questionnaire that was initially developed was pilot tested with representatives of the three international accounting firms in the following countries: Australia Brazil Canada France Germany Italy Japan The Netherlands Sweden The United Kingdom
Analysis of Tax Controversy
in Developed
65
Countries
TABLE 1. Survey Responses Australia Brazil Canada France Germany Italy Japan The Netherlands Sweden The United Kingdom Total
41 27 52 39 56 29 41 42 32 41 412
These countries raise most of the major tax issues facing U.S. based multinational companies. The final questionnaire was distributed to taxpayers, tax administrators, and tax advisory professionals in the countries indicated to secure their opinions as to which tax issues are the most important in the administration of the tax practice in each country. One thousand questionnaires were distributed, and 412 replies were received. The responses from each country can be found in Table 1. Based on the replies received, a first tabulation was made by subject to produce the most important issues in the aggregate. A second tabulation was made of the responses by individual countries to determine the most important issues in each country. These tabulations can be found in Table 2. RESULTS IN AGGREGATE The Most Important
Tax Issues in Developed
Countries
1. Transfer Pricing. The most important subject matter dealing with international examinations by tax authorities is that involving transfer pricing. That is, tax authorities look most closely at pricing to companies in their countries and also pricing by companies from their countries where the transaction involves two related parties. For U.S. tax purposes, this would be considered the Section 482 issue whereby related parties are required to deal with each other on an arms length basis in conducting the buying and selling of inventory in their normal trade or business. From this, one can infer that transfer pricing has been used by taxpayers as a major technique for shifting profits from one country to another.
Transfer Pricing Capital vs. Ordinary Expenses Travel and Entertainment Expenses Tax Depreciation Employee Benefits as Income Management Charges Accrual of Expenses Debt vs. Equity Multiple Taxpayers Penalties Collection Issues Inflation Issues Incentives Rule Making Procedures Recording of Transactions 10 6 9 7
3 4 5 6 7 9 10 3 5
4
1 8
Aus
1 2
Aggregate
3 1 2 4
10
7 9 8
6 5
Bra
2
6 8 9 7 5 10
3 4
Can
9 8 10 2 3 6 -
1 5
Fra
9 6 4 3 7 1 10
2 5
Ger
1
8 2 4 7 10 5
6 3
Ita
TABLE 2. Summary Rankings of Important Tax Issues
6
1 4 8 5 9 IO
3 2
Jap
6 5 8 10 1 2 10
3 4
Neth
4 8 5 9 2 10 1
3 6
Swe
6 2 9 7 8 4 10
3 1
UK
2
3 FY
z 7
z
z
g
b
c
$
5
g
z 2
AnaIysis of Tax Controversy
in Developed
Countries
67
One must keep in mind that the respondents to the questionnaire are conditioned by an environment in which the United States tax rates were higher than the foreign tax rates. Consequently, U.S. companies would normally be the ones involved in shifting profits to foreign countries. However, with declining U.S. tax rates and the stabilization or increase of foreign tax rates, the study suggests that foreign countries are becoming more sensitive to the fact that U.S. companies may want to shift profits from those foreign countries to the United States, in order to enjoy the lower U.S. tax rates. As a result, further research may be required to determine whether this trend will continue, as more experience is gained with the 1986 and 1990 tax legislation in the United States and the decreasing of U.S. tax rates relative to other developed countries. 2. Capital vs. Ordinary Expenses. The second issue is one purely domestic to most countries. It involves the attempt by corporations to take as a tax deduction expenditures that may be considered capital in nature, and therefore, should be capitalized and written off over future years. The issue involved here is more a question of the shifting of income from current years into future years by the deferral of taxable income to those late years. This foreign country issue is not surprising, since this is also a major one in the United States. That is, what constitutes a deductible expense versus what constitutes a capital expenditure is equally important worldwide. 3. Deducting Personal Expenses. The third most critical issue for tax examinations is the extent to which taxpayers are taking personal expenditures as tax deductible business expenses. In certain cases, the U.S. restricts the amount of an entertainment deduction to eighty percent of the expenditure placing a percentage limitation on the deductibility of that amount. In other countries, such as Japan, there is an absolute limitation on the deductibility of such items. This type of expenditure is very often associated with small businesses or closely held companies. Consequently, it is interesting that it has reached such a high priority position. Further research will be necessary to determine the extent to which this issue gives rise to penalties assessed by the tax authorities on taxpayers who seek to deduct items of a personal nature as tax deductible business expenses. 4. Tax Depreciation. Tax depreciation is also primarily a domestic and not an international issue. This matter has been extremely important in the U.S. Internal Revenue Code with issues dealing with what are depreciable assets, what depreciation methods are applicable, and the length of depreciation lives. The results indicated the same constraints apply to foreign countries. Taxable entities very often try to treat an expenditure as having a shorter life or being entitled to an accelerated depreciation method. This has implications not only for foreign companies in general but, in particular, subsidiaries of U.S. based
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parent companies. The reason is that it impacts the calculation of the deemed paid foreign tax credit on dividends received by U.S. corporate shareholders from foreign investee corporations. 5. Employee Benefits as Income. It is surprising that this issue ranks so high in terms of the areas foreign tax authorities delve into on the tax filings of foreign taxpayers. Foreign companies are often entitled to a tax deduction for the item as a trade or business expense, while the employees may not have to report this as gross income. This has implications with regard to employee relations, since the utilization of company property and company facilities for personal purposes is an important form of “de facto” income for employees in many countries. Japan is an important example where employees have significant expense accounts for the promulgation of company business. This can be considered income to the individuals to the extent they use those expenditures for personal purposes. The same is true in Germany, where the utilization of company automobiles is an important fringe benefit, and in the U.K., where the use of club facilities is important. 6. Management Charges. This issue clearly has international implications. After transfer pricing, this is the tax issue that foreign tax authorities look at most closely in determining the extent to which profits are being shifted from a subsidiary company to a foreign parent company that imposes charges for management services rendered for the subsidiary. The foreign countries in this study indicated substantial amounts of income flowed to U.S. parent companies through the use of management charges. This is logical, since such charges will often not require the withholding of foreign taxes on these payments. The technique by which these charges are imposed on the subsidiaries also can be a factor. If it is done in the form of invoices for odd amounts, it may not be scrutinized very closely by foreign tax authorities. 7. Accrual of Expenses. This is a very broad category of domestic tax controversy importance, since foreign companies may very likely be claiming tax deductions for the accrual of expense by setting up reserves when the liability of the corporation has not yet been fully determined. This has accounting as well as tax significance, because there is a significant amount of authority in the accounting literature for accruing such expenses. In some countries, such as Germany, a deduction is not permitted for tax purposes unless it is recorded for accounting purposes. Therefore, to the extent a company tends to over accrue expenses could mean the gaining of tax deductions at an earlier stage. Since the item in question would presumably be deductible at some future point, the major factor here is shifting of profits from current years to future years and capitalizing on the time value of money.
Analysis of Tax Controversy
in Developed
Countries
69
It may seem surprising that this 8. Capital Gains vs. Ordinary Income. issue ranks relatively low, since many countries give a special rate of taxation on capital gains (sometimes zero as in the case of Australia). Proving that an item is capital in nature might very likely result in exemption from taxation. More research needs to be done to ascertain the importance of this issue in those countries in which capital gains get special treatment. This is in sharp contrast to the U.S., which, from 1986 to 1991, did not have a differential in the tax rate applied to capital gains vs. ordinary income, running counter to the tax policy in most countries around the world. This issue clearly has domestic as well as international 9. Debt vs. Equity. implications, since interest is normally deductible in most countries and dividends are not. It should be noted that in countries where the integrated system of taxation is generally applicable, there is a lower tax rate on distributed income. A clear example of this would be Germany, where the tax rate has varied from thirty-four percent to fifty percent by being distributed as opposed to retained. This is true regardless of.whether the recipient of the dividends is a foreign or domestic company. In the international environment, it is even more important, since U.S. parent corporations have used a technique of bringing profits out of a subsidiary company by having a very high debt to equity ratio at the subsidiary level. Specific special tax rules on this subject are covered in the tax laws of France, Germany, and Japan. It is also important where U.S. subsidiaries of foreign corporations are involved. This is because, until recently, the payment of interest was very likely deductible in the U.S., and not subject to U.S. withholding tax. This results from tax treaties that the U.S. has signed with many countries exempting interest payments from U.S. taxation. 10. Multiple Taxpayers. Multiple taxpayers is clearly a domestic issue, although it has international implications. A number of years ago, the United States eliminated the ability of U.S. businesses to proliferate subsidiaries to take advantage of lower tax rates applicable to smaller amounts of corporate income. The tax planning opportunity is still available in some countries, however, and is being utilized so that income attributable to subsidiaries does not get taxed to the parent company. Unless foreign tax examiners are successful in their challenge, the spreading of large amounts of income via a multiplicity of subsidiaries will enable companies to greatly minimize their tax liabilities. RESULTSBY
COUNTRY Australia
For Australia, the three most important issues for tax examinations are transfer pricing, employee benefits, and penalties. This is the first time that the
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results indicated penalties as a major factor in the areas challenged by foreign tax authorities. In the U.S., penalties have become extremely important in the enforcement process. Where taxpayers take a tax deduction to which they are not entitled, or do not report income that they have earned, the penalty weapon challenges taxpayers who take tax positions in a frivolous manner. This is a new phenomenon in the U.S. and, yet, seems to have developed at an early stage in Australia. Brazil For Brazil, a number of subjects were equally weighted with regard to areas of major consequence to tax authorities. A new item not mentioned in the general observations deals with the inflation implications. This is because Brazil is a hyper-inflationary environment. As a result, significant amounts of taxes can be saved by revaluing assets and taking tax depreciation on the new valuation. Since the revaluation does not give rise to taxable income immediately, there are significant savings to the taxpayers. Indeed, many of the items listed from Brazil do not arise in connection with the major areas for examination in other countries. As a result, Brazil is somewhat unique in terms of the tax examinations issues which arise. Canada For Canada, the most important item is that of distinguishing between capital gains and ordinary income. This is because capital gains are non-taxable in Canada. Consequently, a victory by the taxpayer in treating an item as a capital gain versus ordinary income is total exemption from taxation. It is, therefore, not surprising to see that the tax authorities in Canada put a very high priority on examining these items in their evaluation of the results of taxpayers in that country. Tax incentives are also an important issue in Canada for purposes of tax examinations, since they provide the opportunity for taxpayers to avoid taxation completely. A third area of importance in Canada is transfer pricing. This is also not surprising, given the geographical proximity between the United States companies and their subsidiaries in Canada and the volume of commerce that results. France A wide variety of issues of contention exists between the tax authorities and taxpayers in France. Transfer pricing and management charges, however, are the two most important areas of controversy. These apply particu!arly to international transactions, since these two items have been used in recent years by U.S. parents with French subsidiaries to shift profits from France to the United States.
Am&is of Tax Controversyin Developed Cowbies
71
Transfer pricing is of high concern in Germany. The extremely high tax rate in Germany (fifty percent) compared with that in the U.S. (thirty-four percent in current years) makes this issue expected. Clearly, German tax authorities are particularly sensitive to the difference in tax rates. Thus, they look for all foreign companies, (not just those from the United States) seeking to shift profits out of Germany to avoid their higher tax rates. Other areas of major controversy involving Germany are debt vs. equity issues, management charges into Germany, branch tax issues, employee benefits, and non-taxable transactions. The branch tax issue is important to international banks, since there are many American banks with operations in Germany that seek to reduce their tax liabilities by minimizing branch income. In addition, the constructive dividends issue is important, because Germany imposes a significantly lesser amount of taxation on distributed profits. Moving profits out of Germany means German companies will show a lower amount of overall tax liability. Italy In the case of Italy, one of the most important areas of tax contention deals with accounting requirements. This is different from many other countries. One can glean from this, that there is a close tie between the way in which transactions are recorded for accounting purposes and the way they are treated for tax purposes. The extent that a company does not record an expense for accounting purposes precludes it from getting a deduction for tax purposes. This would produce a challenge from the Italian tax authorities. The other major issues of tax disagreement in Italy deal with tax depreciation, capital vs. ordinary expense determination, and travel and entertainment expenses. All of these fall into those categories seen more commonly in other countries. Japan The areas of greatest disagreement between taxpayers and the tax authorities in Japan deal with travel and entertainment expenses and capital vs. ordinary expenditures. Entertainment expenses are not deductible for all practical purposes in Japan. Therefore, if an expenditure is so categorized, the tax authorities in Japan have an opportunity of raising significantly greater amounts of revenue. Similarly, since capital expenditures are generally not deductible in Japan, a determination that an item is capital in nature provides the tax authorities with a motive for investigation. From an international standpoint, the third area of major importance for tax examination in Japan deals with transfer pricing. The interesting element here is that it does not relate to transfer pricing between a U.S. parent and a Japanese subsidiary, but rather
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between a Japanese parent and U.S. subsidiaries. in the public record dealing with the Toyota automobiles to the United States.
& TAXATION,
l(1)
1992
Reference to this was made Motor Company sales of
Netherlands The responses from the Netherlands provided a significant listing of areas of examination by Dutch tax authorities, all having somewhat equal weighting. First seen in the study at a highly weighted level is the deductibility of personal expenses on individual tax returns. This is a domestic tax issue of high importance in the Netherlands. On the corporate side, an area of equal importance deals with the determination of debt vs. equity. This is because interest expenses are deductible, whereas dividends are not. The debt vs. equity issue as well as transfer pricing tax controversies have international implications of importance to the Dutch tax authorities. Also important in the Netherlands is the determination of whether an expenditure is capital or ordinary in nature.
Sweden For Sweden, the results indicated that the utilization of multiple taxpayers and the accrual of expenses are the two most important areas of contention between the Swedish tax authorities and taxpayers. Given the very high tax rates in Sweden, tax planning involves the proliferation of companies in the corporate groups, giving the opportunity to lower the tax rate by using the lower brackets of taxation for corporations. In addition, when an expense is not properly accrued in Sweden, it also presents an area of contention due to the time value of money implication.
United Kingdom For the United Kingdom, one of the major areas of controversy between Inland Revenue and taxpayers is the issue of capital vs. ordinary expenditures. In addition, capital cost allowances (tax depreciation) is important in the United Kingdom. Both of these items deal with the determination of what can be written off immediately vs. what must be capitalized and either not deducted at all or deducted over a period of time in the future. In addition, from the standpoint of international issues, debt vs. equity and transfer pricing are areas of high importance. Given the fact that there is a significant amount of commercial intercourse between the United States and the United Kingdom, it is not surprising that tax authorities from both nations are now examining these issues with close scrutiny.
Analysis of Tax Controversy
in Developed
Countries
73
CONCLUSIONS This study has been able to identify those tax issues that are receiving the greatest attention of tax authorities in ten major developed countries of the world other than the United States. It has ranked those areas of tax controversy so that one can see, in descending order, where most controversy exists between the taxpayers and the tax administration. Furthermore, from this study, one can determine which areas are mostly focused on international versus domestic issues. This research has sought to break ground in an area in which much of the information to date has been anecdotal in nature. The study attempted to identify the major issues emerging from the growing sophistication of tax controversies with tax authorities around the world. The U.S. Internal Revenue Service has the reputation, on a global basis, of being the most aggressive (and perhaps the most knowledgeable) tax authority from the standpoint of challenging taxpayers. Just as the sophistication of the developed countries around the world has grown in commercial terms, the sophistication in dealing with tax matters has also grown. Given the globalization of world economies, the international tax implications of this study should be expanded from the standpoint of the extent to which capital is moving from some countries to other parts of the world. The current study focused to some extent on international tax transactions that involve U.S. based companies going to other countries. On the other hand, the developments of the 1980s and presumably the 199Os, will give rise to tax issues that will be raised by the significant amount of inbound investment into the United States. The Europe 1992 phenomenon alone will provide this. The United States has now become a relatively low tax rate country. Consequently, the past inclination of U.S. companies to shift profits abroad is probably being reversed with U.S. companies seeking to avoid excess foreign tax credits. The extent to which the countries represented in this survey will adopt policies by tax authorities to prevent the shifting of profits back to the U.S. should be explored. APPENDIX Survey of Major Issues Being Raised with Corporate Taxpayers by Tax Authorities in Selected Foreign Countries
This questionnaire is part of a study designed in conjunction with international accounting firms to learn more about major issues being raised by tax authorities in selected foreign countries with corporate taxpayers.
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& TAXATION,
l(1)
1992
The importance of this project is in large part attributable to the recent globalization of the economies of the world. Since little empirical work has been done in this area to date, the results of this study should prove relevant to all readers. The completed questionnaires are processed by automated equipment which summarizes the answers in statistical form so that individual respondents cannot be identified. The individual responses to the questionnaire will remain confidential. We thank you for your participation and look forward to supplying you with the results of our research.
1.
Does the country in which your tax activity is located have the equivalent of the United States Internal Service - i.e., a tax authority which audits tax returns for compliance with the tax laws? 1.
2.
YES
1 1
2.
NO[
1
If your answer to question #1 is yes, what is the title of that tax authority?
If your answer to #I is no, go to question #7. 3.
How would you rate the degree of similarity between the taxpayer and tax authority referred to in question I, and the taxpayer and the IRS with respect to the following dimensions.
Identical A.
B.
Independence of tax authority from taxpayer in relation to: 1. Rule-making 2. Collection 3. Enforcement Voluntary disclosure versus nonvoluntary disclosure on the part of the taxpayer.
t
i
[ ]
[
I
Similar
t
;
[ 1
[
1
Dissimilar
f
i
[ 1
[
1
Totally Different
t
;
[ 1
[
1
Analysis of Tax Controversy 4.
A. B.
in Developed
75
Countries
Please list the key factors in your country that are the tax issues of importance. Please prioritize these factors in descending order (i.e., 1 = highest; 10 = lowest). RATING
FACTORS 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 5.
Most Important
Very Important
Important
[ 1 [ 1
[
1
[
1
Occasionally Important
1 1 [ 1
[ I [ 1
[
[
1
Least Important
[
1
1
From the factors listed above, evaluate the first five key factors and rate them with respect to the following criteria as highest priority determinants of the ranking in question #4.
Least Occasionally Most Very Factor #l Important Important Important Important Important a. Frequency i.e., how often does this issue arise in an examination of a taxpayer in your country? [
b.
1
Dollar value i.e., the amount adjustment. [
[ of money
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1 in your
1
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country
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1
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to this
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C.
Political, Economic Environment i.e., to what extent does this factor affect lawmaking, financial reporting, etc.?
d.
Industry Related i.e., does this type of disagreement arise more often within a particular industry such as banking, insurance, etc.?
e.
Other. Please specify.
[
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1
INTERNATIONAL
76
Factor #2 Frequency a. b. Dollar value Political, C. Economic Environment d. Industry Related e. Other. Please Specify.
Factor #3 a. b. C.
d.
e.
Frequency Dollar value Political, Economic Environment Industry Related Other. Please Specify.
Factor #4 Frequency a. b. Dollar value Political, C. Economic Environment d. Industry Related
Most Important
ACCOUNTING
Very Important
1992
AUDITING
& TAXATION,
l(1)
Important
Occasionally Important
Least Important
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Most Important
Very Important
Important
Occasionally Important
Least Important
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Most Important
Very Important
Important
Occasionally Important
Least Important
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71
[
1
[
1
[
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]
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1
[
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1
Analysis of Tax Controversy in Developed
e.
Other. Please Specify.
Factor #5 a. Frequency b. Dollar value Political, C. Economic Environment d. Industry Related e. Other. Please Specify.
I
Most Important
C.
d.
e.
6.
Very Important
[
1
Important
[
1
Occasionally Important
[
1
Least Important
I
[
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[
1
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1
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together.
Most Important Frequency Dollar value Political, Economic Environment Industry Related Other. Please Specify.
1
[
All 5 factors considered
a. b.
[
1
71
Countries
Very Important
Important
Occasionally Important
Least Important
[
I
[
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[
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[
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1
The following is a list of variables that have been cited as important issues of conflict between the IRS and taxpayers in the United States. How would you rank these factors in your country?
INTERNATIONAL
78
FACTOR 1. Tax depreciation 2. Capital versus ordinary expenditure 3. Debt versus equity (Interest versus dividends) 4. Financing of receivables 5. Travel & Entertainment Expenditures 6. Lease versus purchase of assets 7. Executive compensation & retirement allowances 8. Cross Border Transactions 9. Mergers & Acquisitions 10. Tax Shelter Investment
7.
Most Important
ACCOUNTING
Very Important
1992
AUDITING
& TAXATION,
l(1)
Important
Occasionally Important
Irrelevant
[
1
[
1
[ 1
[
[
I
[ 1
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[ 1
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[
1
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[ 1
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Please describe what method, if any, is employed ensure that taxpayers comply with tax laws.
1
[
1
by your government
to
Analysis of Tax Controversy
in Developed
Countries
79
REFERENCES Bowman, John W. 1984. “IRS Procedures-Getting Through the Maze,” Journal of Accountancy, 158 (October): 93-108. Dubin, Jeffrey A., Michael A. Graetz, and Louis L. Wilde. 1990. “The Changing Face of Tax Enforcement 1978-1988,” Tax Lawyer, 43 (Summer): 893-914. Gordon, Newman & Burton. 1986. “International Examination Issues,” 77re Tax Executive, Spring: 213-227. Hoeflick, M.H. 1983. “Of Reason, Germanship, and Taxes: A Jurisprudential and Gowes Theoretical Approach to the Problem of Voluntary Compliance,” American Journal of Tax Policy, 2 (Spring): 79-88. Kirkwood, Peter, and Charles Muller. 1984. “Tax Policy and Administration,” Florida Bar Journal, 58 (November): 615-618. Merritt, James E. 1984. “New Procedures Used by the IRS to Attack Tax Shelters,” Tax Section, State Bur of California, 10 (Summer): 6-19. Millman, Stephen L., and Guy J. Harpo, Jr. 1984. “Current Partnership Audit Issues,” New York University 48th Annual Institute on Federal Taxation, pp. 48-l to 48-37. Muller, Robert E. 1990. “The Unagreed Case,” Michigan Bar Journal, 69 (November): 11641169. Parisius, David K. 1990. “Government Tax Investigations and Foreign Secrecy Laws,” International Tax Journal, 16 (Fall): 275302. Price, Charles F. 1990. “IRS Audit and Appeals File Data,” Oil & Gus Tax Quarterly, 39 (September): 75-87. Wright, Deloris R. 1984. “Economics, Intangibles, and Section 482,” International Tux Journal, 10 (March): 223-232.