Slowly but surely, developed nations are closing ranks on an international tax agreement intended to crack down global companies parking profits in low-tax jurisdictions. Nice idea in theory, hugely complicated for compliance and tax officers in practice.
The Organization for Economic Cooperation and Development issued its final package of measures in early October known as the Base Erosion and Profit Shifting (BEPS) project. Those 15 recommendations are key to an ambitious global effort by G-20 nations to improve consistency and transparency among tax authorities worldwide. The measures represent “the most fundamental changes to international tax rules in almost a century,” OECD Secretary General Angel Gurría said in a statement.
Those BEPS recommendations will now be presented to the G-20 leaders during a summit meeting in Turkey in November. G-20 and OECD countries will then incorporate many of the actions into domestic law.
The measure that will have the most immediate effect for compliance programs addresses transfer pricing arrangements, where companies redistribute profits by charging for goods or services sold by one subsidiary to another, typically located in different countries. To address this concern, the BEPS project provides for a three-tiered approach to transfer-pricing documentation and reporting, which will create several new compliance challenges for global businesses.
Although many countries currently have transfer pricing documentation rules, and companies have a regular process for producing some of that documentation, the new reporting requirements are “quite different than existing transfer pricing documentation rules,” says Barbara Angus, a principal at EY’s international tax practice. Corporate tax departments will need to compare how their existing reporting requirements differ from the BEPS approach, she says.
The logic behind the BEPS plan was to give multinational companies an easier time complying with transfer pricing documentation by having all countries require the same type of filing. “Unfortunately, it’s turned out to be much more of a compliance burden,” says Brett Weaver, partner-in-charge of tax transparency services at KPMG.
This new three-tiered documentation approach will involve:
Country-by-country reports. Global companies headquartered in OECD and G-20 countries with total revenue of at least €750 million ($853 million) must collect and report annually to the tax authority of the parent company essential financial data for each country where the business operates. “The country-by-country reporting template is a brand new concept, so that makes it particularly significant because companies will have to get ready for a type of reporting that they’ve never had to do before,” Angus says.
“The country-by-country reporting template is a brand new concept, so that makes it particularly significant because companies will have to get ready for a type of reporting that they’ve never had to do before.”
Barbara Angus, Principal, International Tax Practice, EY
Companies will need to report, for example, profit before income tax and income tax paid and accrued, total employment, capital, retained earnings, and tangible assets in each tax jurisdiction. Companies would also need to identify each entity within the group doing business in a particular tax jurisdiction, and to provide an indication of the business activities each entity engages in. Multinational companies will have to assess this data for each subsidiary in each country and aggregate it.
The compliance headaches are as painful as they sound. “Some companies might keep a significant amount of their data on a line-of-business basis, which might not necessarily mesh with geographic reporting,” Angus says. For this reason, companies will have to assess how they maintain their data currently and what adjustments might be necessary to produce the desired outputs.
According to a global BEPS readiness survey conducted by Thomson Reuters, transfer pricing poses the greatest area of concern. Nearly 80 percent of 180 corporate tax executives said they plan to devote most of their time to the transfer pricing and country-by-country reporting elements of the BEPS action plan over the next few months.
Many are conducting dry runs—using last year’s information, for example—to see what data they need and where gaps are in their systems, Angus says.
Master file reports. In addition to country-by-country reports, companies would also need to provide high-level information regarding their global business operations and transfer pricing policies in a standardized master file. Tax authorities will, for the first time, have visibility into a company’s total global supply chain structure across its entire operation, not just in one region.
TRANSFER PRICING & COUNTRY-BY-COUNTRY REPORTING
Below is a partial text addressing transfer pricing documentation and country-by-country reports from the executive summary of the 2015 BEPS final report.
This report contains revised standards for transfer pricing documentation and a template for Country-by-Country Reporting of income, taxes paid and certain measures of economic activity.
Action 13 of the Action Plan on Base Erosion and Profit Shifting (BEPS Action Plan, OECD, 2013) requires the development of “rules regarding transfer pricing documentation to enhance transparency for tax administration, taking into consideration the compliance costs for business. The rules to be developed will include a requirement that MNEs provide all relevant governments with needed information on their global allocation of the income, economic activity and taxes paid among countries according to a common template”.
In response to this requirement, a three-tiered standardized approach to transfer pricing documentation has been developed. First, the guidance on transfer pricing documentation requires multinational enterprises (MNEs) to provide tax administrations with high-level information regarding their global business operations and transfer pricing policies in a “master file” that is to be available to all relevant tax administrations.
Second, it requires that detailed transactional transfer pricing documentation be provided in a “local file” specific to each country, identifying material related party transactions, the amounts involved in those transactions, and the company’s analysis of the transfer pricing determinations they have made with regard to those transactions.
Third, large MNEs are required to file a Country-by-Country Report that will provide annually and for each tax jurisdiction in which they do business the amount of revenue, profit before income tax and income tax paid and accrued. It also requires MNEs to report their number of employees, stated capital, retained earnings and tangible assets in each tax jurisdiction. Finally, it requires MNEs to identify each entity within the group doing business in a particular tax jurisdiction and to provide an indication of the business activities each entity engages in.
Taken together, these three documents (master file, local file and Country-by-Country Report) will require taxpayers to articulate consistent transfer pricing positions and will provide tax administrations with useful information to assess transfer pricing risks, make determinations about where audit resources can most effectively be deployed, and, in the event audits are called for, provide information to commence and target audit inquiries.
This information should make it easier for tax administrations to identify whether companies have engaged in transfer pricing and other practices that have the effect of artificially shifting substantial amounts of income into tax-advantaged environments. The countries participating in the BEPS project agree that these new reporting provisions, and the transparency they will encourage, will contribute to the objective of understanding, controlling, and tackling BEPS behaviors.
“Having a vision into the overall company-wide business strategy, risks, and approach—showing that big picture to individual tax authorities—is something that’s been excluded from transfer pricing documentation historically,” Weaver says. It’s going to require some effort on the part of companies to figure out what consistent story they want to tell tax authorities, he says.
Many companies are looking at how to align that discussion with their segment reporting to the Securities and Exchange Commission, Weaver says. “In many instances, that probably will be a good alignment, but for some companies the detail that will be required there might go beyond what they’re doing for segment reporting,” he says.
Comprehensive tax technology solutions will be necessary to comply with both master file and country-by-country reporting requirements. According to the Thomson Reuters survey, however, 57 percent of respondents said they don’t believe IT systems on the market today are sufficient to help them comply.
The survey also found that 51 percent of respondents have a database of intra-company agreements and tax rulings to comply with the new transfer pricing documentation requirements, but 67 percent said they do not feel secure about their IT systems and how they integrate with their transfer pricing documentation.
Local file reports. Companies also will be required to provide transactional transfer pricing documentation in a “local file” in each country, intended to supplement the master file. The local file calls for more detailed information relevant to the transfer pricing analysis for transactions taking place between a local country affiliate and associated companies in different countries.
Companies also for the first time will be required to disclose their management reporting structure. Most tax departments have never had to deal with HR data around transfer pricing compliance, Weaver says. That means the finance group should make sure that all relevant stakeholders—foremost the HR department—are involved as the tax compliance team gathers necessary data, he says.
If companies decide to use statutory accounts as their data source, which may be maintained at the local level, “that could mean you may need to involve stakeholders around the world,” Angus says. If that’s the case, companies will need to decide which entities around the world have responsibility for statutory accounts.
Local file reports must also include, for example, relevant financial information regarding related-party transactions, the amounts involved in those transactions, and the company’s analysis of the transfer pricing determinations it has made regarding those transactions.
More to Come
What’s next? The biggest questions are around how to implement all the BEPS recommendations: which countries will adopt them, when, and how consistent the various implementations will be across borders.
According to the Thomson Reuters survey, many companies are not prepared for the BEPS reporting requirements—although companies in some regions are more prepared than others. Of those surveyed, 59 percent of respondents from European companies said they are actively preparing, compared to 48 percent of companies in the United States and Asia Pacific.
U.S. companies in particular should not wait on the actions of Congress or the Treasury Department before they begin to prepare for the BEPS reporting requirements, since many other countries are keen on collecting this data.
“Indeed, the change already has begun,” Thomson Reuters said in the survey. “Several countries—including the United Kingdom, Australia, Spain, Mexico, the Netherlands, Poland, South Korea, and China—have proposed new corporate tax rules reflecting the tenets of the BEPS action plan.”
“Companies should plan on the fact that they’re going to have to put this information together,” Weaver says, “even if the United States doesn’t ask for master and local file information.”