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- 19 Nov 2015
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The Bare Truth About Luxury Business & Tax

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In the first of an exclusive legal series on Luxury Society, international law firm Baker & McKenzie tackles the latest tax hurdles facing the industry.

Earlier this year, the Luxury and Fashion practice group of international law firm Baker & McKenzie launched the Global Legal Guide for Luxury and Fashion Companies, the first-ever comprehensive global guide to all legal matters relating to the $254 billion industry.It includes contributions from more than 225 lawyers and economists across its global practices.

In the first of this ongoing and exclusive series with Luxury Society on luxury legal issues, Baker & McKenzie summarises a detailed chapter, included within the Guide, on the complex tax challenges facing the industry.


 Transfer pricing is a fertile issue for luxury, due to the vast potential revenue that may be placed in issue 


The Scene

There are a number of recent significant events that have spurned a change in the tenor and approach of tax audits in the United States and globally, all of which impact Luxury and Fashion Companies.

One key element, though not of recent vintage, is the economic recession as all taxing authorities are aggressively searching for revenues. Transfer pricing is a fertile issue for Luxury & Fashion companies due to the inherent subjective nature of the area and the vast potential revenue that may be placed in issue.

Another key development that arguably has spurned this change is the OECD’s Base Erosion Profit Shifting (“BEPS”) project. Related to this effort, the OECD has projects involving the definition of intangibles and related issues of how they should be treated for tax and valuation purposes, transfer pricing risk assessment, transfer pricing documentation, permanent establishment definitions and determinations, and business restructurings.


 These projects have also been highly publicised, drawing the deep attention of the G-20 and the press 


While these OECD projects are in different stages of development, the concepts have weaved into the thought process and fabric of all tax audits.

These projects have also been highly publicised, drawing the deep attention of the G-20 and the press. The press has been most visible here with sound bytes and stories, though often based on less-than-informed facts (and often times purely erroneous facts).

These sound bytes and stories have spurned strong political attitudes and a sense of social responsibility that has added fuel to the fire of tax audits. Indeed, they have given the notion of taxpayer abuse and that earnings are not properly reported.


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There are vast revenues at stake if tax is not managed correctly


The element most critical to U.S. tax audits has been the creation of the first ever Transfer Pricing Director at the National Office of the Internal Revenue Service.

The stated goals of the Transfer Pricing Director were: (1) to conduct a full level of factual discovery at the Examination level so that cases were properly developed and understood for resolution or further administrative review; (2) to seek to resolve cases at the lowest administrative level; and (3) to target for litigation only those cases appropriate for that forum.

These are noble goals as many cases were pushed through the Examination stage with poor fact development and often unrealistic and untenable adjustments. This caused cases to move through the administrative system (and sometimes to litigation) with poor preparation by the IRS.


 Cases were bogged down in Appeals and often sent back to Examination for more development 


Accordingly, cases were bogged down in Appeals and often sent back to Examination for more development. Not only did this slow down the ability to resolve cases promptly, it often prompted both the taxpayer and the IRS to reach resolutions that were principled but instead agreed just to get a case closed. Cases that proceeded to the U.S. Tax Court were often not well-prepared by the IRS and the IRS’s win record was poor at best.

The Transfer Pricing Director hired numerous team members all over the country and each key audit had one of these individuals attached to the Examination team as the eyes and ears of the Director. Templates on how to manage and conduct the factual discovery were prepared and provided to the Examination teams to assure a complete analysis. Audit work plans were to be more detailed and, as stated below, response time to information document requests (“IDRs”) was to be rigorously enforced.

The most visible sign of the results of this action, however, is the number of IRS personnel who comprise the audit team. The mere size of the team often makes it difficult to get matters closed as the opinions and views of the team members can vary and often significantly.


 Failure to meet this deadline will result in the IRS seeking enforcement 


The Information Document Request (“IDR”) process has also changed. The IRS has become more reluctant to give long extensions on IDRs. The new procedure effective October 1, 2013 brings even more rigidity to the IDR process, in which a due date will be set for IDRs and if IDRs remain unanswered for more than 15 days after the set due date, the IDRs will go to a pre-summons phase to compel a response through a judicial process.

Failure to meet this deadline will result in the IRS seeking enforcement through the issuance of a formal Summons. In essence, IRS is looking to all possible avenues of approach to support its proposed adjustments.


The Issue & Challenges

The requests for interviews and plant tours are common, but the current practice and detail has taken on a new element. Currently, we are experiencing, requests to interview, key personnel of all entities in the supply chain. The numbers of the individuals proposed to be interviewed is not insubstantial and again this is time-consuming. Given that the IRS has limited budget to travel, they have made good use of video conferencing, although for large cases in designated industries, budgets do exist. Common issues include limiting those who can question the witnesses, whether transcripts or recordings would be allowed, and scheduling of the interviews within the period of the audit plan.


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These cross-border issues will undoubtedly lead to the potential of double taxation. Simply looking at the plethora of issues vented in the press today where taxing authorities are seeking the same revenues within a supply chain, it is likely that these issues will come before the respective Competent Authorities.

Academically this sounds acceptable; practically it can be catastrophic. Can the staffing at the Competent Authorities handle this work load? How long will it take to seek some form of resolution? Will Competent Authorities become selective in the cases that they accept? How will the delayed resolutions affect taxpayer’s financial statements? Notwithstanding all of these concerns, how efficient will the resolution process be where the Competent Authorities have different conceptual views for the issues involved?


 These cross-border issues will undoubtedly lead to the potential of double taxation 


The Conclusion

If cases are not resolved at Examination, a slightly new thought process must now take place. The IRS plans to develop cases well at the Examination level for either settlement at that level or to assure a detailed understanding of the case as it proceeds as an unresolved controversy and possibly to litigation. This knowledge must be thoroughly considered before proceeding.

The changes described above regarding the tenor and approach of the US tax audits may seem subtle, but the impact of these IRS efforts can give rise to greater taxpayer costs and more precise strategies to resolve these cases. While it sounds rather trite to say care must be exercised in these matters to be successful, that is in fact the reality today. Read more by requesting your copy of the Global Legal Guide.





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Baker & McKenzie defined the global law firm in the 20th century, and is redefining it to meet the challenges of the global economy in the 21st. The firm brings to matters the instinctively global perspective, deep market knowledge and insights of more than 12,000 people in 77 offices worldwide.

www.bakermckenzie.com