The Evolving Landscape of Cross-Border Tax Examination: Critical strategies for tax departments to consider and pitfalls to avoid in the complex landscape of foreign tax audits.

• Author: Akins, Sean

Our clients and our practice group members are increasingly occupied (and preoccupied) not only with challenges from the Internal Revenue Service but also with audit and enforcement actions from foreign tax authorities. In a world where many jurisdictions are increasingly hungry for tax revenues, the foreign subsidiaries of large multinationals can be ripe targets. These non-US audit and enforcement actions are becoming high-dollar and high-stake, and foreign tax authorities can aggressively pursue facts in US-style discovery during the examination phase and push cases to foreign administrative appeals and even litigation more frequently.

This article examines practical considerations at the various stages of a significant foreign audit--from who will take the lead in preparing responses to inquiries all the way to considerations for correlative relief in the case of an adverse outcome. Throughout, we highlight process and procedural inflection points that tax groups should keep in mind.

Managing the Foreign Audit

When a foreign affiliate receives an audit notice, one of the first major decisions is determining who will manage (and who else will be involved in) the audit defense, a decision that may be more complicated than in a domestic audit because of the multitude of advisors and stakeholders. Sometimes the answer will be predetermined--depending on how the tax department is organized and the resources already deployed--but if significant issues (such as tax-sensitive restructurings) are lurking or if an aggressive local authority might challenge company-wide positions (for example, on transfer pricing), it can help to deactivate autopilot and give some thought to the composition of the responding audit defense team.

Typically, the audit defense team will involve some combination of employees of the local affiliate, the group's central tax department, and (in the case of a large-dollar or high-stakes audit) the group's central legal department. The team may also include local outside tax counsel and tax advisors as well as global outside counsel and tax advisors for significant issues. Here are some factors that inform the decision about whom it makes sense to involve in an aggressive foreign audit:

* Resources. This one is obvious. Engaging outside counsel is generally more expensive but provides more human-power where in-house time (or local-country tax expertise) is limited. Another consideration is that elevating an audit internally, either to the group's central tax or legal function, can unlock additional company resources to which the local team generally may not have access. And, internal coordination with other stakeholders interested in the process (for example, the legal department, accounting, etc.) allows for more insight and planning.

* Material or group-wide recurring issues. Special consideration is warranted for transactions with material tax positions, transfer pricing, or other issues that affect many affiliates and that are likely to recur (for example, a management fee or a royalty that many similarly situated entities pay). In these cases, it is important to put forward a coherent and consistent narrative to tax authorities across jurisdictions. Preparing centrally managed outlines or collections of fact-based documents that can be used by local teams across the corporate group in responding to audits on the same issue can be particularly helpful. This approach requires some upfront coordination and effort but can be a significant resource-saver on the back end and avoid duplicative efforts among local affiliates.

* Likelihood of litigation. A large-dollar issue for which there is significant risk exposure may warrant a well-resourced team comprising in-house and outside personnel. With an issue that may be substantial enough to litigate (if necessary), it may make sense to involve the group's general counsel. For example, the company's general counsel may be able to assist with electronic discovery, identifying outside counsel, and protecting privilege for internal fact-gathering. If litigation is likely, depending on the local jurisdiction's rules on work-product protections, it may make sense for the general counsel team to put a litigation hold in place, in order to protect from spoliation essential communications and other documents.

* Access to information. Another consideration is whether the audit issue is one where most of the information is at the local level (for example, a question about equipment depreciation) or elsewhere in the group (for example, transfer pricing questions about activities performed by another group member or questions about a...