1.1 Introduction
In 2018 the OECD has introduced a new strategy to improve co-operative compliance amongst its member states. It was based on the OECD Project ‘International Compliance Assurance Programme’ (ICAP). The key principles addressed are: transparency, trust and understanding. Tax jurisdictions aim to work together with Multinational Enterprises (MNEs) to promote tax compliance and to prevent issues that might arise in connection with the company’s risk factors.
Transparency, trust and understanding have always been important in dealing with horizontal monitoring in the Netherlands. Clear communication between taxpayers and tax administration on an equal level is expected to improve overall tax compliance.
The Dutch tax authorities have taken a next step to apply horizontal monitoring. They have reshaped the way horizontal monitoring is implemented in the Netherlands. The tax authorities put more emphasis on transparency and expect more insight in companies.
1.2 Three categories
Since the start of horizontal monitoring in the Netherlands, large and medium sized companies have the option to agree on a covenant with the authorities, addressing their tax risks upfront and facilitating a solid tax return at the end of the year. In practice it became clear however that companies often engaged in a minimalistic ‘ticking off the boxes’ and that the tax authorities did not save as much manpower as they had expected.
The most important change in the new horizontal monitoring approach is the introduction of three distinct categories of taxpayers. The first category will consist of the top 100 large companies in the Netherlands. Existing covenants for this group will disappear and an ‘individual monitoring plan’ will be enforced. As far as we know now, the tax authorities will not implement the individual monitoring plan in a standardised way. There will however be more emphasis on the operational side of the analysis. The tax authorities have stated that they intent to move from ‘tell me’ to ‘show me’. Although the intention seems clear enough, the practical application and the format is still unclear. Questions that arise include: how does the internal control system work, how did a company get to a certain risk analysis? It is expected that the tax authorities will publish a certain format to guide relevant companies. Transfer Pricing documentation will be very likely one of the key instruments to ‘show’ the tax authorities how a company operates. In addition, the tax authorities consider a Tax Control Framework (TCF) to be a good way to establish procedures in order to identify a company’s tax risks and how to manage them. A TCF has also been recognized by the OECD as an important tool to enable practicable horizontal monitoring.
The second category consists of companies that meet one or more of the following requirements: (i) net turnover of 40 million euros or more, (ii) asset value of 20 million euros or more, (iii) 250 or more employees.
This second group of companies will still have the option to apply a covenant, although it will be stricter and only run for a limited period of three years after which the company is expected to perform a new self-risk-assessment. Existing covenants will end in December 2022.
The last category is that of the medium sized companies. These companies do not fit in any of the categories named above and will not be able to receive an individual covenant. Such companies will, however, be able to apply a covenant via a tax intermediary. This third category does raise questions in respect of the final responsibility and the compliance burden for companies. Do companies need to fit into a standardised format that is available for tax intermediaries or is a customized approach still possible? What additional requirements will be applied for an intermediary in order to be allowed to obtain a new style covenant? Additional clarification will be necessary for companies to allow a proper evaluation of the potential benefits of the covenant-instrument.
1.3 Tax control framework
A Tax Control Framework is an essential instrument to manage a company’s tax exposure. The TCF addresses amongst others tax strategy, transfer pricing policy as well as internal controls and monitoring. It shows how a company manages its tax compliance and it may become decisive in ensuring a smooth tax return process. A proper TCF substantially contributes to mutual trust between a company and the tax authorities and will likely result in an acceptable tax return. Therefore, companies should consider investing in a proper control framework. Once it has been put in place and if properly maintained it could make a real difference in avoiding future disputes and save time and tax compliance costs. However, there is a crucial missing link to the TCF concept as it stands today: there is little real guidance yet on what would be considered a proper TCF. Although it will likely require some level of customisation for an individual company, it would increase the potential success of the TCF when there would be clear general guidance on what should always be included and what could be considered optional. At the end of the day companies will want to weigh the expected costs and benefits of applying a TCF. This could also include considering a phased approach where a company starts with e.g. a transfer pricing control framework (TPCF) and expand gradually towards a full TCF.
1.4 ICAP
The TCF concept has not only gained traction in the Netherlands. There is an international trend in respect of enhanced relationships and co-operative compliance that requires a good functioning TCF. ICAP is a good example. The risk analysis performed under ICAP relies heavily on the documentation package and results of the TCF.
The ICAP programme will put full spotlights on transfer pricing as it is international by nature and already supported by substantial international documentation requirements. A TPCF would complete the circle: concepts will be aligned with monitoring and control to provide tax authorities with a sufficient comfort level to accept the results. A good and efficient TPCF can facilitate a trust-based relationship with the tax authorities, easing the way to obtaining advanced certainty and reducing the risks of costly transfer pricing disputes. Also, internationally there is a clear shift towards a “show me” approach rather than the more traditional “tell me” approach.
Cooperative compliance and enhanced relationship models in combination with TCF as an instrument to “show” how a company is dealing with its tax compliance could result in a win – win situation for both taxpayers and tax authorities. Of course this will depend on the level of consensus on what to expect from a TPCF. This includes practical considerations related to the size and complexity of companies.