- Approximately $75.3 billion of Fortune 500 capital is under dispute with tax authorities, equivalent to more than half of their profit growth in 2017
- 63% of tax leaders predict the amount of tax under dispute to rise over the next five years
- Locating and isolating, for taxable purposes, the real source of corporate value is the single greatest challenge facing businesses and authorities, according to 72% of tax leaders
- 57% of corporate tax leaders struggle to clearly articulate their tax calculations and liabilities for tax authorities
The scale of current tax disputes presents a significant threat to hard won profit growth in the Fortune 500, according to The Shape of Water a new report launched by leading global law firm Baker McKenzie on the rise and drivers of disputed tax.
The 150 Fortune 500 respondents interviewed by Baker McKenzie confirm they have up to $22.6 billion of revenue subject to tax disputes. If the entire Fortune 500 is managing tax disputes in similar proportions, that equates to an eye-watering $75.3 billion. To put that figure in perspective, it would be equivalent to 7.5% of the profit made by the Fortune 500 in 2017. In the same year, average profit growth in the Fortune 500 stood at 12.4% and in 2016 it was 6%.
Unsurprisingly, 60% of tax leaders said that this represents an increase in tax disputes over the last five years, but in more unsettling news, 63% predict that the amount of tax under dispute will continue to rise over the next five years.
"In the past, there was a clear connection between physical market activity – such as sales and manufacturing – and taxable value," said Simone Musa, Partner and Chair of Baker McKenzie's Global Tax Committee. "Today, companies and regulators struggle to attribute profit neatly to particular activities and jurisdictions, as organizations routinely work with digitized networks and dispersed workforces and customer bases."
Defining corporate value
Locating and isolating the source of corporate value is the single greatest challenge facing organizations and authorities, according to 72% of tax leaders. It is the leading cause of contention between organizations and regulators and the key driver for tax disputes.
"Transfer pricing is the most common source of disputes, with issues arising from conflicting valuations of assets and disagreement on the location and scope of value-generating activities," said Mark Delaney, Partner and Head of Baker McKenzie's UK Tax Practice. "The amorphous nature of value created by digitization is perhaps the most significant contributor to the high number of transfer pricing disputes we see today, and that are predicted over the coming five years."
The digitization of business is creating particular complexity for a broad spectrum of businesses including technology, consumer goods, and financial services companies. In each instance, corporate value is proving intangible, non-linear and high-tech value flows freely across multiple jurisdictions, without the need for customs or local operations. In this context, accurately capturing the true scale and location of taxable liability is immensely difficult.
Tax authorities have been slow to respond to these changes and where tax structures were once led by national legislation, some authorities are now taking a piecemeal approach, applying concepts not yet incorporated into law and retroactively imposing them on past tax filings, leaving organizations reeling. A clear majority, 72%, of tax leaders say that current tax regimes are not fit for purpose.
"This is particularly true in Asia, where industries have accelerated through the incremental stages of development typically seen in Western markets. These sweeping advances have created a significant challenge for authorities, now several steps behind. When applying old rules to new models, a rise in disputes is inevitable," added Steven Sieker, a Hong Kong based tax Partner at Baker McKenzie.
The complexity and volume of tax disputes is taking a toll on multinationals’ ability to manage them efficiently. More than half (57%) struggle to clearly articulate their tax calculations and liabilities and two thirds (64%) worry about their ability to meet the demands of global revenue authorities.
Timelines for resolving disputes are growing ever longer, owing to global divergences between regulatory regimes and the difficulty in unravelling the source of taxable value. With more issues to settle and greater scope for negotiation, extensive consultations between tax leaders and multiple authorities are commonplace. Two thirds (67%) of tax leaders say it’s taking longer than ever to solve cross-border disputes.
While litigation is falling out of favor with multinationals, negotiated settlements have grown in popularity with 85% of respondents citing it as an effective dispute resolution method. From arbitrated settlements to advance pricing agreements, complexity is creating a greater need for discussion, consideration and partnership between tax leaders and authorities.
Effective dispute management
Our research led us to conclude that multinationals must act to build scalable and effective dispute management systems that are better designed to capture corporate value. Tax directors will be held professionally and personally accountable for reaching accurate tax calculations, regardless of the difficulty of reaching an objectively correct figure in today's environment.
George Clarke, a Washington, DC based tax Partner at Baker McKenzie said, “The old rules-based system for resolving tax disputes has been abandoned as tax authorities and corporates become increasingly polarized. Where once 'fairness' was the guiding principle for determining taxable value, today, strategic planning is as important as technical skill during tax negotiations."
Tax directors must be aware of new trends in enforcement – particularly audit digitization and hiring practices – that will affect how they interact with authorities. Innovations in electronic invoicing and data capture now provide global tax authorities with an unprecedented view of the ‘digital footprint’ of corporate value – emboldening them to conduct increasingly far-reaching investigations.