Tax audits … when quantity prevailed

This article appears in the October issue of our International Corporate Structures Newsletter.

During my career, I approached tax audits with a core strategy which I adapted to fit the particular country and the type of tax inspector handling the audit. One particular audit in a major European country demonstrates the need to adapt to local circumstances – however idiosyncratic they may be. Let me explain.

The audit was being conducted by an experienced tax inspector who had been given a deadline to close the audit. Throughout the process he only spent one day a week maximum in our local office.

During the first few weeks he asked for a business overview, which my local colleagues produced based upon the detail contained in the global consolidated financials. My local finance colleague told me that the inspector never actually read anything but just reacted negatively to the number of pages provided to him. We later realised that he lacked commercial awareness and as the overview was business driven he could not relate it to tax. He was more concerned with volume.

I asked for a call to be set up between him, my local finance colleague and me. We deliberately did not involve our tax advisers as there was nothing for them to do, although I did ask them to try to find out some background information on the tax inspector. They gave me some helpful information but said that local tax inspectors never agree to regular telephone meetings.

We had the call and I realised the tax inspector knew the areas he wanted to focus on (primarily intercompany transactions and agreements), but he didn’t want to work excessively himself. I explained to him that I would be more than happy to speak with him weekly to ensure he received the requested information and answers to any questions. However, I could only do this by phone as I had no budget to cover the cost of regular weekly trips from the UK. He was aware that our local people were finance specialists and not tax, so he agreed.

During our weekly calls we established precisely what he needed and provided him with written support where necessary. We recognised that he would be looking to receive:

• a written detailed global business overview with a link to the local activity;

• a local market transfer pricing report including details of intercompany transactions and their economic support;

• copies of intercompany agreements; and

• flow charts of the various financial systems

In those pre BEPS days we generally prepared the information on an ‘as requested’ basis, except in relation to certain major countries for which we produced information in advance.

Our tax inspector appreciated the information provided, especially the intercompany agreements for the major transactions. Incidentally, the inspector’s report requested we should have agreements for all intercompany transactions and not just the majors.

The inspector required everything in hard copy and in binders. To maximise the number of binders I asked my colleagues to print everything single sided. Maybe not eco friendly but it met his requirements as evidently his superiors would judge him on quantity as well as quality!

During the weekly calls with the tax inspector we developed a mutual trust and respect which is crucial in closing an audit amicably. They also enabled me to learn some things about him:

• he was technically strong;

• he lacked commercial awareness and needed help to understand the business context;

• he was a stickler for the process he needed to go through; and

• he was almost as obsessed with volume of information as with quality.

We handled the audit accordingly, negotiated where needed and achieved a successful conclusion with minor adjustments.

Oh and our tax advisers couldn’t believe we’d actually held regular tax audit meetings over the phone. Just proves if you don’t ask …