IRS Teaming Up With Overseas Tax Authorities on Joint Audits

The Internal Revenue Service is working so closely with other countries to scrutinize taxable cross-border transactions that it's now experimenting with the idea of conducting joint audits—and it's apparently looking for corporate taxpayers to serve as guinea pigs.

According to tax experts, the IRS has enlisted a handful of corporate taxpayers to participate in a joint audit pilot program to determine whether revenue agents in different countries can get to a quicker, more efficient resolution of tax issues by working on the audit side by side. The IRS declined to comment on the joint audit effort directly, but tax experts say the IRS is conducting a handful of audits jointly with its counterparts in Australia, and it's in conversations to establish similar joint audits with agents in Britain and the Netherlands. “This is very much in the start-up phase,” says David Swenson, a partner with PwC.

As companies have continued to expand into global markets, tax authorities have come to recognize they need to cooperate more with other jurisdictions, says Mike Patton, a partner at the law firm DLA Piper who specializes in transfer pricing. Transfer pricing involves intra-company transactions that might get favorable terms within a corporate entity, but are taxable as if they were arm's-length transactions among unrelated parties. Where pricing judgment is involved, and when those transactions cross international borders, sorting out tax liabilities can get complicated and adversarial. “Multinational companies by definition have revenues and transactions across multiple countries,” he says. “Joint audits are an effort by the tax authorities to mirror what the companies are doing.”

The IRS has been working through the Organization for Economic Cooperation and Development and its Forum on Tax Administration to develop more cooperative strategies for collecting tax. In late 2010, the forum launched an initiative to develop a joint audit approach, where two or more tax agencies would work together to audit a single multinational taxpayer. IRS Commissioner Doug Shulman, who has promised new ideas for straightforward, efficient tax collection, is spearheading U.S. involvement in the joint audit project, as chairman of the Forum on Tax Administration. Shulman said in a speech late last year the IRS was just getting underway with its first joint audits with hopes it would serve as a roadmap for further coordinated action with other governments.

The forum, and Shulman as its leader, see the joint audit as a way to get more transparency from taxpayers and to reach a faster, more efficient conclusion on the complex tax issues being audited, says Joseph Calianno, a partner with the international tax practice at Grant Thornton. “From the taxpayer's point of view, it could speed up the audit process when both countries are auditing the same transaction and you might get resolution of issues more quickly,” he says. “In some instances it could even reduce the taxpayer's burden.” Producing documents and answering questions for one audit team working together is bound to be more efficient than doing the same for two separate audit teams operating independently, he says.

“Multinational companies by definition have revenues and transactions across multiple countries. Joint audits are an effort by the tax authorities to mirror what the companies are doing.”

—Mike Patton,

Partner,

DLA Piper

The forum determined that a joint audit would be useful where agents see heightened risk associated with cross-border transactions, transfer pricing, transactions in low-tax or no-tax jurisdictions, or those involving companies with a history of non-compliance. A joint audit team would consist of audit leaders and examiners from each country, as well as “competent authority” representatives. In the United States, competent authorities are normally brought into international tax disputes when a taxpayer believes two different tax jurisdictions are looking at a single transaction in a way that results in double taxation. IRS-competent authority agents would take up the cause on behalf of the taxpayer and try to resolve the dispute with the other tax authority.

“The process can take a long time, and the taxpayer is on the sidelines,” says Patti Burquest, a managing director at tax and consulting firm RSM McGladrey. “The participation of the competent authorities in the joint audit suggests that the taxpayer will get a faster and more consistent resolution of the issues and that double taxation issues will be resolved concurrently,” she says. That will create certainty and relief much earlier than current processes.

JOINT AUDIT OBJECTIVES

The following excerpt from the OECD Joint Audit Report outlines the main objectives of a joint audit:

A joint audit should be considered:

when there is an added value compared to the procedures of exchange of information;

when the countries have a common or complementary interest in the fiscal affairs of one or more related taxpayers, and

in order to obtain a complete picture of a taxpayer's tax liability in reference to some portion of its operations or to a specific transaction, where a domestic audit is not sufficient.

The main objectives of joint audits are:

to reduce taxpayer burden of multiple countries conducting audits of similar interests and/or transactions;

to improve the case-selection of tax audits by mutual risk identification and analyses;

to provide as much evidence as possible that the correct and complete income, expense and tax are reported in accordance with national legislation, through efficient and effective administrative cooperation;

to enhance the awareness of tax officers of the opportunities available in dealing with international tax risks;

to gain understanding of the differences in legislation and procedures and if necessary to accelerate the Mutual Agreement procedure by early involvement of the Competent Authority, where double taxation is involved;

to recognize and learn from the different audit methodologies in participating countries;

to harness the particular strengths and expertise of team members (for example, valuation experts, economists or industry experts) from different administrations for the benefit of the joint audit;

to identify and improve further areas of collaboration; and

for all participating countries to reach a joint/mutual agreement on the audit results to avoid double taxation, as applicable.

A joint audit can also contribute to:

the development of enhanced relationships between revenue bodies and taxpayers;

enhancing the compliance of multinational companies;

providing certainty for taxpayers;

a reduction in compliance costs for taxpayers through the resolution of tax issues in a timely and cost effective manner;

more effective management of tax issues in “real time”;

increasing the efficiency and effectiveness of revenue bodies; and

more effective challenges to those taxpayers who push legal boundaries and who rely on lack of transparency in cross-border transactions.

Source: OECD Joint Audit Report.

That doesn't mean corporate taxpayers are expected to line up eagerly for the joint audit approach, which apparently is entirely voluntary for taxpayers at this early stage. “While a joint audit may be of substantial value to some taxpayers, it raises concerns for others,” Swenson says. Some companies are skeptical that tax staff will find it less burdensome to go through a joint audit than separate audits, and they're concerned about whether budget-pressured government entities will allocate adequate resources to perform joint audits.

Nancy Iredale, a partner with the tax practice at law firm Paul Hastings, says the joint audit approach could even be more complicated rather than less. “Think about the practical difficulties in an examination to begin with, and now you're involved with a coordinated examination with staff across two jurisdictions,” she says. “[Those difficulties] could multiply exponentially.”

Companies also need to worry about privacy, Iredale says. The IRS concedes in the OECD report that it needs to be cautious about privacy concerns because U.S. taxpayers have sued in the past for improperly divulging confidential or proprietary information to tax collectors in other countries. “Companies have to be worried about the disclosure of confidential information in jurisdictions that do not have the same kinds of protections for taxpayers that the United States does,” Iredale says.

Mike Dolan, a director at KPMG, says his firm has discussed the idea of volunteering for a joint audit with about a half dozen clients who might see some appeal in resolving audit issues more quickly. “There are some who are watching this carefully to see how it works,” Dolan says. “Does it create efficiencies? Or am I asking for trouble by volunteering to have two administrators look at me intensively at the same time?”

Experts disagree on whether the joint audit might also ease the burden companies face in making disclosures in tax filings and financial statements about where they have uncertainty in their tax positions. Some say a quicker resolution of tax issues would theoretically make those uncertainty disclosures easier and shorter. Iredale, for one, isn't jumping to any conclusions. “It's just too soon to tell,” she says.

The path forward is anything but clear, as far as Todd Behrend is concerned. The principal in international tax with tax services firm Ryan says multinational taxpayers will welcome anything that creates some increased certainty around how tax issues will be resolved. “It's going to be a challenging process, but to the extent there's an opportunity for people to get clarity on a multinational basis, there's a lot of interest in that.”