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Tax disputes threaten profit growth of top US companies
TAX disputes are threatening to wipe out more than half the profit growth of Fortune 500 companies in the US - and the amount involved is predicted to grow in the coming years.
Locating and isolating the real source of corporate value for tax purposes is also said to be the single greatest challenge facing businesses and authorities today.
These were the key issues raised in new research from global law firm Baker McKenzie, which spoke to 150 tax leaders from Fortune 500 companies, across key sectors such as healthcare & pharmaceutical, financial services, transport, technology, and consumer goods.
Tax disputes, simply defined, refer to disagreements - typically between tax-collecting authorities, either domestically or across borders - over the amount of tax an entity has to pay.
Baker McKenzie's report, The Shape of Water, says that the scale of current tax disputes presents a significant threat to hard-won profit growth in the Fortune 500. The 150 tax leaders interviewed said they have up to US$22.6 billion of revenue that is subject to tax disputes.
"If the entire Fortune 500 is managing tax disputes in similar proportions, that equates to an eye-watering US$75.3 billion," said Steven Sieker, chair of Baker McKenzie's Asia-Pacific Tax Practice Group.
"To put that figure in perspective, it would be equivalent to 7.5 per cent 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 per cent and in 2016 it was 6 per cent."
Baker McKenzie's report says the exposure to rising tax disputes is higher still for "hyper-growth organisations" - those with an annual turnover growth of more than 20 per cent; these face up to US$5 billion greater exposure than their lower growth peers, owing to a challenging combination of unique value generation models and less mature compliance and dispute-management experience.
Sixty per cent of the tax leaders interviewed by the firm also predicted that the amount of tax under dispute will continue to rise over the next five years.
Simone Musa, partner and chair of Baker McKenzie's Global Tax Committee, explained: "In the past, there was a clear connection between market activity - such as sales and manufacturing - and taxable value. Today, companies and regulators alike struggle to attribute profit neatly to particular activities and jurisdictions, as organisations routinely work with digitised networks and dispersed customer bases."
The digitisation of business, in particular, increases the complexity for a broad spectrum of businesses, including technology, consumer goods, and financial services companies.
Baker McKenzie's report said that corporate value is proving intangible, non-linear and high-tech, with value flowing freely across multiple jurisdictions, without the need for customs or local operations.
Accurately capturing the true scale and location of taxable liability is therefore immensely difficult in this context.
Mark Delaney, partner and head of Baker McKenzie's UK Tax Practice, said: "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. The amorphous nature of value created by digitisation 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."
Transfer pricing refers to how entities price goods, services and intangibles, thereby affecting the amount that is taxed.
Almost three-quarters (72 per cent) of the tax leaders interviewed said that locating and isolating the source of corporate value is the single greatest challenge facing organisations and authorities today; they said it is also the leading cause of contention between organisations and regulators, as well as the key driver for tax disputes.
Aggravating the issue is the perception that tax authorities have been slow to respond to these changes.
Where tax structures were once led by national legislation, Baker McKenzie have noted that some authorities are now taking a piecemeal approach, applying concepts not yet incorporated into law and retroactively imposing them on past tax filings.
The majority (72 per cent) of the tax leaders interviewed said that current tax regimes are not fit for purpose, with the the new digitised reality significantly outpacing tax regulation.
Mr Sieker points out that 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," he said.
To combat this, the global law firm believes that multinational companies need to build scalable and effective dispute management systems that are better designed to capture corporate value, while their tax directors must be aware of new trends in enforcement - particularly audit digitisation and hiring practices - that will affect how they interact with the authorities.
George Clarke, a Washington DC-based tax partner at Baker McKenzie, said: "Where once 'fairness' was the guiding principle for determining taxable value, today, strategic planning is as important as technical skill during tax negotiations."