The five stages of tax disputes: from audit to resolution

Multinational organizations are navigating a bold reality as tax authorities pursue an increasingly adversarial stance and employ harder hitting powers to obtain information. In today’s challenging environment, audits are on the rise and significant tax penalties are being applied more frequently. Technology is also helping tax authorities assess enormous volumes of data to identify compliance issues and trigger potentially costly audits.

KPMG research confirms that behavior is changing among tax authorities worldwide. Almost 90 percent of tax dispute professionals surveyed agreed that the global tax environment has become “more or much more challenging” in recent years. In addition, 94 percent of respondents believe tax disputes are increasingly difficult to resolve.

In this article, KPMG tax professionals examine the five stages of tax disputes and what to expect in today’s complex reality — including guidance on the timing of challenges, dispute-settlement possibilities, and why disputes are on the rise as scrutiny grows more intense.

What are the five stages of tax disputes?

There are five broad stages of disputes. By defining and understanding them, tax leaders can often secure an edge in planning their approach, from audit to resolution.

Audit and information gathering

As tax authorities review filings and request documentation, it’s essential to provide accurate, timely and consistent documentation and responses. Strong documentation and clear communication that will support a clear narrative or strategy can prevent misunderstandings and help resolve issues early.
Assessment and adjustment

If the tax authority identifies discrepancies, they may propose adjustments. At this stage, critically evaluate the authority’s position, assess the financial and reputational impact, and prepare a robust technical defense. The goal is to review assumptions and narrow the scope of disagreement.
Administrative review/appeal

Most jurisdictions provide an internal appeal process. The objective here is to resolve the dispute without litigation by presenting a well-supported case to a review body. This stage often allows for more balanced consideration and may open the door to settlement. Provide information and maintain a positive relationship while asserting your organization’s rights and presenting potential solutions.
Tax litigation

If administrative remedies fail, the dispute may proceed to court. Your objective then shifts to achieving a favorable legal judgment while managing costs, timelines and public exposure. Litigation requires a rigorous legal strategy and may set a precedent that impacts future operations.
Post-litigation/resolution

Following a ruling or decision, the focus turns to implementation — including payment, adjustments or further appeals. Also evaluate lessons learned and update tax approaches to help mitigate future risks.

Knowing when to challenge authorities can impact outcomes

Challenging the powers of tax authorities is a sensitive but sometimes necessary aspect of dispute management and resolution. It’s important to note that the timing of challenges can significantly influence outcomes.

Early-stage challenges

Businesses can question an auditor’s information-gathering and -collection powers. Challenges to information requests should typically be raised early in the audit stage. If a request is overly broad, irrelevant or infringes on legal privileges, you should respond promptly, asserting rights while maintaining a cooperative tone. Delaying such challenges may be interpreted as acquiescence.

Late-stage challenges

Challenging the exercise of discretionary authority is also an option. Tax authorities often exercise discretion in areas such as penalty assessments or interpretation of ambiguous rules. Challenges to these decisions are usually more effective during the appeals stage, where there is greater opportunity for independent review. However, groundwork for such challenges should be clearly defined during earlier interactions by documenting inconsistencies or procedural concerns.

Settlement considerations across dispute stages

Organizations facing audits are advised to closely review the strength of their initial arguments and to take a realistic approach toward the likelihood of a resolution — versus the potential for a case to set off costly and time-consuming litigation. One of the keys is to map out a strategic path forward on how to tackle a dispute across stages, and test the strategy.

At the audit stage

Organizations may pursue principled settlements — agreements based on a shared understanding of the facts and applicable law. This can save valuable time and resources but requires confidence in the strength of your position. You might also be invited to engage with authorities when an audit has concluded to determine whether the audit will lead to a resolution or litigation. There is also the possibility of solving issues by rescinding transactions that have caused unintended and adverse tax consequences.

At the appeals stage

Compromise becomes more common. Both parties may reassess their risks and seek a mutually acceptable resolution. Motivations include avoiding litigation costs, reducing uncertainty and preserving relationships. Internal approval processes for large settlements typically involve senior management and the board of directors.

At the litigation stage

Settlement still remains an option. At this stage, decisions are often driven by risk-management considerations, including the likelihood of success, potential precedential impact and financial exposure. Compromise settlements typically involve concessions from both sides.

At the audit stage At the appeals stage At the litigation stage

At the audit stage

Organizations may pursue principled settlements — agreements based on a shared understanding of the facts and applicable law. This can save valuable time and resources but requires confidence in the strength of your position. You might also be invited to engage with authorities when an audit has concluded to determine whether the audit will lead to a resolution or litigation. There is also the possibility of solving issues by rescinding transactions that have caused unintended and adverse tax consequences.

At the appeals stage

Compromise becomes more common. Both parties may reassess their risks and seek a mutually acceptable resolution. Motivations include avoiding litigation costs, reducing uncertainty and preserving relationships. Internal approval processes for large settlements typically involve senior management and the board of directors.

At the litigation stage

Settlement still remains an option. At this stage, decisions are often driven by risk-management considerations, including the likelihood of success, potential precedential impact and financial exposure. Compromise settlements typically involve concessions from both sides.

Early dispute strategy and the power of a consistent narrative

In today’s reality, particularly in jurisdictions where litigation is favored as an approach to resolve tax disputes, tax litigators are increasingly entering the dispute far earlier than the court stage, sometimes pre-audit. This entails working with the organization to be audit-ready for large or high-risk transactions before the tax authorities begin their audit. Tax litigators often also assist in assessing and managing risks, building legal arguments, and advancing a strong and consistent narrative is advanced early on to help ensure a higher success rate if the matter proceeds to trial.

For an organization and its tax leaders, it can also help to clearly define from the start a consistent narrative that illustrates to authorities the reasons for actions taken — supported with key documentation and backed by a confident approach. It’s also important along the way to be aware of how a response, strategy or settlement on a current dispute can have an impact on future scrutiny and reasoning by authorities — setting a precedent regarding subsequent audits, queries and settlements.

Why disputes are rising across jurisdictions

Authorities continue to take an aggressive stance in terms of scrutiny, timelines and document requests as audits multiply in frequency and scope. Their harder hitting approach to information gathering includes asserting formal access rights, conducting formal interviews and issuing summonses. In addition, new or increased penalties are being legislated in many jurisdictions.

Governments and tax authorities are raising the bar on audits and the number of disputes for several reasons.

On the one hand is the ongoing need for financially strained governments to increase revenues. At the same time, tax approaches enabled under the Base Erosion and Profit Shifting (BEPS) initiative have seen multinational enterprises making use of loopholes in tax rules to artificially shift profits to low- or no-tax locations in order to reduce taxable income. Authorities are closing loopholes and pursuing more aggressive scrutiny.

Also having an impact are the OECD’s Global Anti-Base Erosion Rules (GloBE) that aim to ensure that large multinational enterprises with revenues exceeding €750 million (US$885 million) pay tax on income arising in every jurisdiction of their operations.

Not to be underestimated is the unprecedented impact of technology that is enabling tax authorities as never before to evaluate enormous volumes of data and uncover compliance risks. In many cases, authorities are implementing new data and analytics capabilities to assess taxpayers. An additional factor heightening the pressure on global organizations is the trend of tax authorities and governments increasingly sharing information across borders.

Core drivers of multi-jurisdictional tax disputes

Resolving disputes with multi-jurisdictional impact may require the pursuit of alternative dispute resolution mechanisms such as mutual agreement procedures (MAPs) or arbitration under tax treaties.

Disputes involving cross‑border taxation often arise in areas such as transfer pricing. In such cases, tax authorities may claim that profits have been artificially shifted to other jurisdictions. A single issue like transfer pricing can lead to an adjustment of profits already taxed in another jurisdiction, resulting in double taxation.

Also in the sights of authorities are tax disputes involving deduction/non-inclusion (D/NI) practices that exploit differences in tax laws between two or more jurisdictions. One jurisdiction may allow a deduction in respect of a cross-border payment, the receipt of which is not fully included as income in the other country.

Another major source of disputes is permanent establishment (PE) risk. Tax authorities may assert that a company has a taxable presence in their jurisdiction, even when the company believes its activities fall short of the determining threshold. Similarly, disputes may arise over the characterization of income, whether certain earnings should be treated as business profits, dividends, royalties or capital gains — each of which may be taxed differently.

Key takeaways

Tax audits and disputes are an inevitable risk for multinationals operating in today’s complex regulatory landscape. However, they need not be purely reactive or adversarial. By understanding the root causes of disputes, managing each stage of the process strategically and approaching settlement decisions with discipline, outcomes can be improved significantly.

1. Always be audit-ready

Taking a proactive approach in the face of potential audits is crucial. Have a game plan in place to manage inquiries and audits, with a particular focus on large or high-risk transactions. Dedicating resources and external expertise to manage risk can help save significant time and costs.

2. Prioritize documentation that delivers

Maintain robust and timely documentation at all times to support your position and explain the rationale behind it when the authorities come calling. Tax authorities are sharpening their focus and enhancing their capabilities to uncover inappropriate, insufficient or inconsistent documentation.

3. Engage to resolve the issue

Clear communication, a cooperative stance and sound tax approaches supported by appropriate documentation can help prevent misunderstandings and potentially resolve issues early in the dispute process.