Research Trends and Conclusions: Corporate Tax 2010
Jessica Harvey -
As higher unemployment and lower company profits shrink tax revenue, the financial fall-out has pushed tax further up the political agenda. Tax rules and requirements are becoming ever more stringent in a bid to regulate an increasingly frontier-less marketplace and maximise economic recovery. We examine the challenges that face the legal marketplace, the spoils for the victor in this corporate tax tug-of-war, and the changes that are reshaping the industry.
For lawyers, rising litigation and the need for compliance-related advice has mitigated the shortfall of transactional activity but the market remains highly competitive. Facing tough competition from major accountancy practices looking to undertake more legal work, law firms are mirroring this activity, aiming to spread into the remit of the Big Four. We examine the challenges that face the legal marketplace, the spoils for the victor in this corporate tax tug-of-war, and the changes that are reshaping the industry.
Transaction-Related Corporate Tax
With the M&A market silenced by the events of the past 24 months, transaction-related corporate tax work has fallen globally. The banking finance shortfall has severely curtailed activity: many of the lawyers that our researchers spoke to identify a limited pool of transactional work and an increasing number of bids falling through because the financing simply has not been there. US bank-driven and structured finance work has plummeted, creating significant challenges for transaction-geared city practices as one source warns, “The fantastic seam of work generated by structured products and tax-based financing transactions has significantly contracted”.
Transactional work that does exist calls for smaller teams and greater experience at the helm. As Murray Clayson at Freshfields Bruckhaus Deringer LLP notes, “a few key players at the banks remain brilliantly innovative and skilled at bringing complex transactions to execution”. This need for experience creates some practical challenges for many leading firms, as Steve Edge at Slaughter and May explains “current deal, advisory and contentious work is generally calling for a higher level of experience and technical expertise, from senior associates and up. It is difficult to find transaction work for younger lawyers to cut their teeth on.” As Edge continues, what marks this recession out is the number of challenging factors acting simultaneously: “in the past, if the corporate side is down, we expect the financing to be up, but this recession is different from that point of view owing to the shortage of liquidity from the collapse in the market. You don’t often find that all those factors are happening at the same time”. All in all, this has left a significant space to fill for corporate tax practitioners.
A Hard Line
There is always a need for tax advice, however. A significant amount of compliance work continues to present itself. With the benefits of a terrific international network and the ability to offer tax services to audit clients, many leading lawyers realise the accountancy firms hold the advantage for day-to-day tax advice. This does not deter legal firms from carving an increasing share of this line of work. In Ireland, a new disclosure regime that recognises legal privilege is likely to bring more work for lawyers there and has generated some criticism from the accountancy firms over unfair competitive advantage. As many international practices are forced to rethink their business models, the trend for law firms to fashion a compliance niche is likely to continue with more and more setting their sights on increasing activities in this area. In Hong Kong, lawyers highlight compliance as one of the biggest trends in the region owing to a more aggressive stance being taken by tax authorities. And they are not alone – tax authorities globally are being more zealous in their investigations.
In the US, lawyers are experiencing increased levels of audit and tax controversy work, dealing with appeals and preparing for litigation. The codification of the doctrine of economic substance by congress is creating particular concern for clients. With the prospect of a 40% penalty applicable irrespective of good faith reliance, the Act’s strict new penalty provisions impose a larger risk on transactions that could potentially fail the economic substance test. Lawyers are being increasingly tasked with providing legal opinions weighing this heightened level of risk. Many have been encouraging the treasury to issue some much-needed guidance to make the statute more manageable, but for now, with significant financial stakes, the situation remains extremely problematic. Adding to the mix, as the 2011 expiration of the Bush tax measures looms, many lawyers are preparing their practices for an increase in tax policy related issues. Public companies and auditors are growing even more prudent with regards to their tax positions, as Barnet Phillips at Skadden Arps Slate Meagher & Flom LLP describes, “there is a demand for greater diligence with respect to tax positions that have been taken”. Lawyers are spending more time advising accountants, those preparing tax returns and in-house counsel as a result. At Winston & Strawn LLP, Deborah Goldstein notes an increase in contentious Internal Revenue Service audits, particularly of investment funds and high net worth individuals. One particular challenge of IRS audits is the need to fight to maintain legal privilege: “It has become standard operating procedure for the IRS to request privileged material, accounting work papers and even to issue summonses for lawyers’ opinion letters if the IRS believes the privilege has been waived. In light of the IRS challenges in this regard, there is an increasing focus on taking appropriate steps to maintain the privilege.” As tax controversy work continues, some firms have looked to increase their tax controversy might with the hiring of former in-house IRS professionals. As expected in an economic downturn, litigation is very much in vogue.
In the UK, however, the mood is set to shift to a more conciliatory level – the recently announced “softening” of Her Majesty’s Revenue and Customs (HMRC) hard line Litigation and Settlement Strategy is leading to a greater capacity for dispute resolution outside the courtroom. Practitioners observe an increase in revenue, mirroring the commercial sphere, when considering the resolution of disputes, exploring alternative dispute resolution and mediation avenues. The £505million settlement figure reached between HMRC and AstraZeneca, despite pre-dating the U-turn, is a prime example of this and indeed supports the view held by many leading corporate tax practitioners that there has always been room for negotiation at the table. Familiar territory for many lawyers, it is easy to argue that this places the legal teams at an advantage for this line of work. As Tim Sanders at Skadden Arps Slate Meagher & Flom LLP observes, with tax being “fertile ground for litigation” and an increase in major taxpayer to taxpayer actions, a number of magic and silver circle firms “are looking at establishing or giving more prominence to existing tax arbitration and litigation teams”. That said, while a continuing pressure on fees has seen clients keep a keen eye on costs and with many law firms taking the steps above, for advocacy and advice, the Bar remains an invaluable source. With further litigation on the horizon, some commercial solicitors are thinking strategically, involving counsel early on in the dispute to ensure a tightly-knit team and then proceeding in line with counsel’s management of the dispute at any future hearings.
Transfer Pricing
Another clear and inescapable trend comes in the form of transfer pricing. Traditionally the exercise of accountancy firms, legal teams are keen to build up their practices in this expanding field. For global firms, harnessing their own international legal network to meet client activity is central to attracting this line of work.
Some firms have adopted a strategic and innovative approach, hiring transfer pricing experts from accountancy practices. Freshfields Bruckhaus Deringer LLP’s recruitment of Daniel Beeton as Head of Transfer Pricing Economics is one such example. With an ability to conduct in-depth economic planning and comparability studies for clients globally, this hiring of outside non-legal tax experts demonstrates the eagerness of legal firms to compete with accountancy teams, offering a bespoke level of service that combines an economic and legal transfer pricing expertise with an advisory and litigation service. Lawyers universally reinforced the growing prominence of transfer pricing for multinational corporations, as one prominent source highlights “tax remains an incredibly important issue for clients. It’s always the tax issue that gets in to the board room”. In the US, tightened regulations, debate surrounding the workability of the international arm’s-length standard and movements toward finding alternative ways of disputing transfer pricing assessments are foreseen, signalling little sign of relent for this developing area.
Private Funds, Politics and Posture
Despite private equity’s slow recovery, private equity funds remain key clients for many. One prominent source highlights an increase in fund structuring and fund reorganisation work: “Several new players are entering the market; many have left the large hedge funds to set up their own investment management businesses”. There also remains a demand for specialist tax advice to counterbalance and restructure assets intended for resale which are being held on to in the unfavourable economic climate. The extent to which this will continue however is limited, as one contributor explains “those that needed to move have now mostly done so”. The wave of restructuring activity lawyers anticipated “simply hasn’t happened”.
After a turbulent and unpredictable economic period, the UK government’s drive toward achieving greater stability and transparency both in the regulation and enforcement of tax avoidance will be welcome news for many of the city’s chief financial officers. For lawyers, this delivers a mixed bag of fortunes. Following years of legislative “tinkering” that generated the need for more tax advice, a more stable tax regime is likely to have the opposite effect (although it is anticipated that consultations over the next year or so will continue to bring activity). In counterbalance, the coalition government’s increase in the rate of capital gains tax to 28 per cent for the higher and additional rate taxpayers has generated further legal work.
For legal practitioners and practices worldwide, the trick will be adapting to stay ahead of the curve. As Steve Edge highlights, corporate tax lawyers “must look to the future shape of their practice to ensure that in three to five years, the practice is adquately staffed at all levels to manage the tax work they then think will be there”. Lawyers will continually need to adjust to mirror client activity; fortunately, they have had plenty of practice. Having undergone such a seismic change in the market, the lawyers in this book demonstrate their first-class ability to meet changing market demands and the colours for which they receive tremendous international recognition.