Global simplicity,local complexity?

Endgame:

Key themes from our sessions

HMRC’s Approach to Penalties and Avoiding Own Goals 7

Thank you for joining our Annual Tax Seminar 2019!I’d like to thank you for attending Baker McKenzie’s 2019 Annual Tax Seminar. For those who attended, and those who we missed, this brochure provides a summary of key takeaways from our core sessions.

It was an engaging, exciting day; our guest speakers provided some fascinating insights, then together in breakout sessions we drilled down into more complex discussions. Though the pace of change looks set to continue for all of us in the international tax environment, we hope that our seminar provoked thought, provided clarity, and began to prompt conclusions for what the future “Endgame” of tax will look like.

With best regards,

Mark

Mark DelaneyHead of London Tax

Phone: +44 (0)207 919 1802Email: mark.delaney@bakermckenzie.com

Contents

Brexit and Beyond: Tax Trends for Financial Services Groups 6

Let’s Get Personnel: Substance and Galvanising Your Business Around It 5

Managing Permanent Establishment Risk: Shooting at a Moving Target 4

Digitalisation: Taxation in the Age of Change 3

www.bakermckenzie.com

The Rules of Engagement 8

Digitalisation is redefining value creation and supply chains. Key factors include the Internet of Things, 3D printing, cloud computing and new entrants/competitors in the market. These create supply chain disruption to which businessesneed to respond.

The supply chain used to be linear, sequential and segmented, so it was easier to understand from a tax perspective. Now the supply chain is a more integrated network with greater connectivity between the various parts.

It’s now necessary to pin down where business value comes from and who are the people contributing to it the most. In the past, companies did not need to respond to such a wide range of queries.

There are some big commercial themes in digitalisation.The pace of change varies among industries. Some have lagged behind e.g. automotive, healthcare, but are now catching up. Other sectors are showing greater digital maturity.

Players in the market have pivoted and business models have changed.

VAT and direct tax consequences. Can a server be a fixed establishment for VAT if there are no people? Could it create a direct tax permanent establishment? We have already seen decisions in some countries to this effect.

How can value be attributed to data? The data itself might not be valuable; it’s the ability to use it or “crunch” it that counts. Once data reaches a critical mass, does that change its value? How does it drive value and to what extent can it be used as a driver of value?

Data privacy and security. Does proper protection in itself have a value? Heavy data regulation e.g. GDPR is having an impact on supply chains.

Surrender of data to tax authorities. An increasing amount of data needs to be surrendered. Country by country (“CbC”) reporting has been described as a “Treasure map” for tax authorities.

Control of risk/tax risk management is increasingly a part of conversations with HMRC. How can risk be allocated and valued? A “Doomsday” approach requires businesses to look at what happens in the event of a “catastrophic” risk, namely who has the ability to absorb or control it?

Digitalisation is causing fundamental change to business models in practically all industries. Businesses are quickly adapting to the reality of a major shift in the way they create value, engage with customers and bring products to market.

Vladimir MilicSenior Associate, Tax

Phone: +44 (0)207 919 1114Email: vladimir.milic @bakermckenzie.com

Jukka Karjalainen Partner, Tax

Phone: +44 (0)207 919 1560Email: jukka.karjalainen @bakermckenzie.com

Kathryn Sewell Senior Associate, Tax

Phone: +44 (0)207 919 1674Email: kathryn.sewell @bakermckenzie.com

3

Digitalisation: Taxation in the Age of Change

Historically stable domestic and international definitions of PE have not prevented the concept bringing about a “fear factor” for the tax function. The risk of criminal investigations, extended statutes of limitations, financial sanctions (penalties and interest), consequences for other taxes (namely WHT, VAT and payroll) and conflict with business imperatives are just some of the reasons why PE remains a hot topic. In recent years, in response to globalisation and an increasingly mobile employee workforce, the “traditional” PE threshold has come under pressure. BEPS Action 7 has resulted in changes to the OECD Model Convention and Commentary, with various changes being introduced to target perceived avoidance and abuse of the PE standard. The OECD’s BEPS Project has also resulted in the Multilateral Instrument (Action 15), which, as of today, has been signed by 89 countries and ratified by 33 of those. This will result in over 1000 double taxation agreements changing, bringing about further uncertainty: • Timing. The timing of the MLI’s effect depends on the status

of the signing/ratification process for the respective countries.• Content. It is necessary to “match” which provisions the treaty

counterparties opted into.• Interpretation. The MLI has brought in new and untested

concepts to the PE definition, such as “playing the principal role” and “without material modification”, although the take-up of these new concepts via the MLI has been limited.

• Other changes. The changes must be considered in light of other key developments on the horizon (such as the OECD’s BEPS 2.0 Project).

Tax authorities around the world adopt different approaches to monitoring and challenging PEs. Tax authorities are getting to grips with new sources of data (such as CbCr) and improving their approach towards existing data sources (for example, through exchange of information with other tax authorities and interrogating payroll and customs data). In certain jurisdictions, more aggressive measures (dawn raids, criminal investigations and arbitrary tax assessments) are deployed to put pressure on taxpayers. A starting point for managing PE risk is to evaluate the group structure and supply chain. A common trend amongst many groups has been to implement a reseller/limited risk distributor arrangement. Ultimately, any structuring should be driven by what works for the business and its customers (and should not appear artificial when scrutinised by a tax authority). Controls should be clear and well understood throughout the organisation, and tested and monitored regularly. Defending against the risk of a tax authority PE enquiry really turns on documentation and engagement. Having access to accurate and contemporaneous information that demonstrates how the business functions is critical to defending a PE audit. Whether it is advisable/possible to engage with the tax authority varies on a jurisdiction by jurisdiction basis. Where “no PE” rulings are not available/less common, some comfort in relation to PE can still be sought through pursuing an APA or engaging informally with the tax authority (for example, through a Customer Compliance Manager in the UK).

Oliver PendredSenior Associate, Tax

Phone: +44 (0)207 919 5409Email: oliver.pendred @bakermckenzie.com

Ariane CalloudPartner, Tax

Phone: +33 1 44 17 64 67Email: ariane.calloud @bakermckenzie.com

Christian PortLocal Partner, Tax

Phone: +49 69 2 99 08 654Email: christian.port @bakermckenzie.com

Antonia AzpeitiaPartner, Tax

Phone: +34 91 230 4517Email: mariaantonia.azpeitia @bakermckenzie.com

Michiel KloesLocal Partner, Tax

Phone: +31 20 551 7969Email: michiel.kloes @bakermckenzie.com

As the Multilateral Instrument implements changes to the permanent establishment definition recommended by BEPS Action 7, the threshold for creating a taxable presence for activities overseas is lowering.

Managing Permanent Establishment Risk: Shooting at a Moving Target

4

“Substance” is not a new concept for tax purposes, but the way in which tax authorities approach it has changed. In many jurisdictions (e.g. the UK and Germany), there has been a move towards considering substance at the level of individuals and a move away from less precise measures (e.g. headcount or legal ownership of assets). This is also the focus when examining DEMPE functions. In other jurisdictions (e.g. the USA), the BEPS recommendations may not have changed the law, but they have given additional impetus to the tax authorities in looking at the specific functions performed in different territories.

Tax authorities are increasingly seeking to argue that functions performed by different group entities are sufficiently integrated that a residual profit split is the appropriate transfer pricing methodology. In the past, tax authorities were less likely to view a profit split as the primary, or even secondary, method for determining an entity’s remuneration.

Total system profit is a key measure that tax authorities wish to understand in both audit and APA situations. Tax authorities want to understand what the system profit is and how it is divided among different group entities and counterparties to transactions. Even for unilateral APAs, a two-sided approach is becoming the norm.

The substance of payees is increasingly relevant in the context of withholding taxes and deductions for cross-border payments. For example in assessing beneficial ownership or treaty shopping abuses.

When preparing transfer pricing documentation, general statements about how the functions of an entity should be characterized are unlikely to be adequate. To provide the best defence against future audits, transfer pricing documentation should set out the “DNA” of the company, details of the industry in which it operates, the functions which individuals perform, and the assets it owns and makes use of in carrying on its business.

Taxpayers are playing “audit roulette” where they maintain historical transfer pricing arrangements that no longer reflect the facts. If an entity’s remuneration does not accord with the actual functions performed by relevant individuals for the tax period under audit, taxpayers are at risk of robust challenge from tax authorities.

If taxpayers do not take the initiative at the start of an audit to set out their version of the facts in as much detail as possible, local tax authorities will construct their version regardless, and this may be difficult to displace. In practice, a transfer pricing dispute is unlikely to be won on the basis of the economic analysis. In most cases, it will be won on the basis of the facts.

Whilst not expressly addressed by corporate governance codes, tax is becoming an increasingly important topic on the corporate governance agenda. This is in light of recent corporate governance reforms around transparency and the need to consider the impact of decisions on a wider range of stakeholders (e.g. the introduction of the Wates Principles for large private companies in the UK). Companies should include tax in their corporate governance policies and procedures.

Ultimately, there needs to be a consistent approach to substance for both tax and corporate governance, as both should be telling the same story about the company.

With interpretation by tax authorities still evolving, how should international businesses be approaching their response to substance requirements for IP or corporate holding companies?

Let’s Get Personnel: Substance and Galvanising Your Business Around It

5

David Schultz Senior Associate, Tax

Phone: +44 (0)207 919 1402Email: david.schultz @bakermckenzie.com

Patrick O’Gara,Partner

Phone: +44 (0)207 919 1633Email: patrick.o’gara @bakermckenzie.com

Jo HewittPartner

Phone: +44 (0)207 919 1597Email: jo.hewitt @bakermckenzie.com

Marc LeveyPartner, Tax

Phone: +1 212 891 3944Email: marc.levey @bakermckenzie.com

Corporate tax: the key issue is exit tax charges on transfer of assets from the UK. Most businesses would typically accept exit charges where they are able to secure a corresponding deferred tax asset in the destination country and/or they have tax attributes in the UK that can be used to reduce the tax payable on any exit charge. We believe that HMRC will take an aggressive approach to exit charges and this may be exacerbated by the wide range of filing positions being adopted.

Transfer pricing: the key issue is valuation of assets. This is inherently connected with exit charges and possibly VAT. A common error in Brexit restructuring projects is that clients and advisers look at valuation in isolation rather than from an holistic perspective of the business. To achieve the best financial outcome - normally a low value - businesses should determine the following factors:

• What is being valued? In most cases the transfer of assets results in a business model change, so it is important to perform a contribution analysis for that asset/ part of the business before and after the transfer.

• What the arrangement will look like after the restructuring, what is the appropriate transfer price/ income attributable to that asset/ part of the business.

• The correct valuation. This will involve the business identifying the risks (in particular the commercial and political risks) inherent in that asset/ part of the business, pre- and post- Brexit, and comparing the respective financial results. Other factors to consider in the valuation include whether the post- Brexit structure is less efficient from a tax perspective (as this reduces the valuation).

VAT: Brexit restructurings can either provide an opportunity to implement a cost-efficient structure (e.g. by taking advantage of mismatches between Member States which enable full VAT recovery) or result in a complex and at times costly structure (e.g. for highly integrated business which are partially exempt). To arrive at the best result, it is important to undertake a risk management exercise and explore all possible avenues for the business. Some key considerations for businesses are:

• Ensuring that TOGC treatment can apply so the transfer does not trigger VAT. The UK has recently confirmed that TOGC treatment can apply to cross-border transfers and this is also accepted by the Netherlands.

• Reviewing intercompany arrangements post-restructure so they do not result in an undesirable VAT cost (e.g. if the entity in the destination country has little substance and relies heavily on activities undertaken in the UK). There should be sufficient substance in the destination country to satisfy both tax and regulatory authorities.

• Deciding whether a ruling is appropriate to get confirmation of favourable VAT treatment. This will vary depending on the country involved, but the Dutch authorities are trying to encourage business transfers to the Netherlands and so have been cooperative with taxpayers. Approaching the tax authorities to discuss the business and the envisaged VAT treatment prior to applying for a formal ruling has proved to be successful to date and has resulted in a favourable outcome for a number of businesses.

Regulatory: when considering or engaging in restructuring to manage the impact of Brexit, businesses should factor in regulatory thresholds, substance in the destination country (avoiding optionality of functions and activities), and in particular be mindful of the need for seniority of personnel as the EU has been strict on supervisory expectations.

Brexit restructuring brings different issues for financial services groups for corporate tax, transfer pricing, VAT and regulatory purposes.

Mark AgnewPartner, VAT

Phone: +44 (0)207 919 1620Email: mark.agnew @bakermckenzie.com

Steve LabrumConsultant, Tax

Phone: +44 (0)207 919 1930Email: steve.labrum @bakermckenzie.com

Tom AstonConsultant, Tax

Phone: +44 (0)207 919 1878Email: tom.aston @bakermckenzie.com

Caitlin McErlanePartner, Banking

Phone: +44 (0)207 919 1894Email: caitlin.mcerlane @bakermckenzie.com

Martin MorawskiSenior Associate, Tax

Phone: +31 20 551 7198Email: martin.morawski @bakermckenzie.com

Brexit and Beyond: Tax Trends for Financial Services Groups

6

The penalties landscape. Following HMRC’s internal review of the penalties regime in 2016-17, it was decided that changes were needed as there was a lack of consistency in this area, largely brought about because of a lack of supporting evidence for taxpayers’ penalty positions. This has therefore led to HMRC becoming more aggressive in their approach to assessing penalties for inaccuracies.

The penalties process. Historically penalties were considered something of an afterthought, but we are now seeing HMRC taking a greater interest in taxpayers’ penalties positions early in enquiries. In particular, we have seen HMRC asking upfront questions in initial informal information around the taxpayer’s behaviour and case teams are increasingly requesting written submissions on the taxpayer’s penalties position before taking direct tax settlements to Governance Board.

Culpability (i.e., whether a taxpayer has been careless, deliberate, or careless and deliberate). In addition to taking a more aggressive stance on penalties generally, HMRC are increasingly attempting to stretch the definition of what constitutes deliberate behaviour. It is therefore very important to record and retain contemporaneous evidence of tax positions taken and the taxpayer challenging advice received from third party advisors.

Penalty mitigation. Again, it is becoming increasingly important to compile and retain contemporaneous documentation as regards tax positions taken in returns. Such evidence can be used to demonstrate that reasonable care was taken if HMRC were later to assert that the position gave rise to an inaccuracy in a return.

Penalty suspension – hidden pitfalls. Although HMRC have become more aggressive in imposing penalties, they have shown pragmatism through use of their powers to suspend such penalties,although this can create risks for the taxpayer. In

addition to any specific suspension HMRC may impose, the taxpayer will have to submit all relevant returns (e.g., PAYE, VAT, etc) on time for a specified period of time or the suspension will be lifted and the penalty will become payable without a right of appeal. This can be a difficult requirement to satisfy.

The PDCF and the penalties regime. As the PDCF involves taxpayers accepting that they owe additional tax for earlier years, taking the lead and raising it with HMRC, HMRC have stated that they will treat anything disclosed under the facility as unprompted. Therefore, tax-geared penalties can be mitigated by up to half of the maximum penalty. Throughout the year HMRC has been sending “nudge” letters to some taxpayers suggesting that they register for the PDCF, on the basis that their arrangements are of the type commonly associated with DPT.

How taxpayers are approaching the Profit Diversion Compliance Facilities. Although some advisors are of the view that all taxpayers who receive a “nudge” letter from HMRC have no choice but to register if they want to avoid an enquiry being opened, we consider that the advantages of registration should be properly evaluated. This includes weighing up the benefits of potentially reduced penalties against the full and accurate disclosure required under the facility, likely to involve extensive work, including a review of all of a group’s tax affairs and not just Diverted Profits Tax and transfer pricing. Other factors are the lack of certainty that any penalties assessed will be mitigated, along with the impact on cash flow and financial statements of the immediate tax payment required.

Success of the PDCF. HMRC have already hailed the facility as a success, with the majority of taxpayers identified having registered. This doesn’t accord with what we are seeing in practice. One of the perceived benefits of using the PDCF is that it allows the taxpayer to lead and control the internal investigation process. It is too early to see if this is an actual benefit but it will be interesting to see if in cases where disclosure reports are submitted to HMRC, settlement is reached within the six-month period indicated by HMRC and protracted enquiries are avoided.

What does HMRC’s current approach to penalties mean for how you approach and manage your relationship with HMRC and any disputes that arise?

David JamiesonPartner, VAT

Phone: +44 (0)207 919 1289Email: david.jamieson @bakermckenzie.com

Salli McElligotSenior Associate, Tax

Phone: +44 (0)207 919 1579Email: salli.mcelligot @bakermckenzie.com

Claudine FoxSenior Associate, Tax

Phone: +1 202 835 1657Email: claudine.fox @bakermckenzie.com

HMRC’s Approach to Penalties and Avoiding Own Goals

7

Shift in the relationship dynamic with the case team since the introduction of the HMRC governance process in 2012. The taxpayer’s relationship with their case team used to be critical, but we now have to convince the Governance Board and the case team’s powers are limited. That said, it is important to build rapport and credibility with the team. Where the enquiry has reached a stalemate, it’s helpful to bring in new individuals from within HMRC to get some traction on the discussions.

Pressure for thorough investigations. Increased involvement of the Fraud Investigation team and use of AI means enquiries are more extensive than before. There has been a marked increase in the information and documents requested by HMRC and the way in which these are obtained (e.g. international information gathering powers).

Factors within the taxpayer’s control that can influence the outcome of the enquiry. It is helpful to have a clear idea of the “case theory”, i.e. the affirmative case. Evidence shared with HMRC should be informed by this case theory. It is important that HMRC have access to the business and regular contact throughout the enquiry.

Quality of evidence. Information will often be requested to prove HMRC’s theory or preconceptions. HMRC place the greatest reliance on employee interviews in evidencing how the business works. HMRC will also request employee emails to illustrate the thought processes at the time.

Employee interviews. Employee interviews have the potential to be key and persuasive in supporting your theory of the case. Equally, interviews can be very unhelpful. While interviewees must never be coached, it is essential that interviewees are prepared for what they can expect. Interviewees should give answers honestly, while being mindful of speaking to facts rather than making value judgments and contextualising responses. Accurate transcripts should be taken of interviews and any inaccuracies in HMRC’s notes should be pointed out.

How to engage with HMRC during large scale enquiries, including: the factors influencing HMRC’s approach, tactics for staying on the front foot during the information gathering phase and the rules of engagement for employee interviews.

Jessica EdenPartner, Tax

Phone: +44(0)207 919 1721Email: jessica.eden @bakermckenzie.com

Summer AustinPartner, Tax

Phone: +1 202 835 1643Email: summer.austin @bakermckenzie.com

The Rules of Engagement

8

© 2019 Baker McKenzie. All rights reserved. Baker & McKenzie International is a global law firm with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a “partner” means a person who is a partner or equivalent in such a law firm. Similarly, reference to an “office” means an office of any such law firm.

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We solve complex legal problems across borders and practice areas. Our unique culture, developed over 70 years, enables our 13,000 people to understand local markets and navigate multiple jurisdictions, working together as trusted colleagues and friends to instil confidence in our clients.

Baker & McKenzie International is a global law firm with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a “partner” means a person who is a partner or equivalent in such a law firm. Similarly, reference to an “office” means an office of any such law firm. This may qualify as “Attorney Advertising” requiring notice in some jurisdictions. Prior results do not guarantee similar outcomes.

© 2019 Baker McKenzie. All rights reserved.

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