Multi-national Enterprises Need to Reevaluate Transfer Pricing Documentation (article)
In 2013, the Organisation for Economic Co-operation and Development (OECD) and the G20 Countries developed a 15-Point Action Plan in an effort to address Base Erosion and Profit Shifting (BEPS). The OECD and G20 Countries worked together on this Action Plan in an attempt to address concerns about aggressive tax planning by multi-national enterprises (MNE) to reduce their tax liabilities by shifting profits to low or no tax jurisdictions. Part of the Action Plan called for changing transfer pricing documentation to enhance transparency, certainty, and predictability for tax administrators and taxpayers. The United Kingdom and Australia are two examples of countries that have quickly adopted the transfer pricing documentation guidance. MNEs need to reevaluate their transfer pricing documentation to ensure that it meets the standards set forth by the Action Plan, while considering the nuances of the rules in the various countries in which they do business.
The OECD recognized three major themes that would assist taxpayers and tax administrators in managing BEPS concerns. First, the creation of coherence between the tax rules of sovereign countries would eliminate gaps and frictions that have plagued the global tax system up to this point. Second, the creation of new procedures and regulations that are clear and predictable would reduce the costs accrued by the MNE and encourage accurate transfer pricing assessments and audits made by tax administrators in various jurisdictions. Third, the creation of new guidance that addresses the definition and ownership of intangibles to ensure the appropriate allocation of profits generated by intangibles would provide greater transparency of MNE's value chain.
The Action Plan includes deadlines to finalize the deliverables that will provide detailed guidance to address BEPS concerns. The Actions will be released in two sets of deliverables, the first of which was released on September 16, 2014. The remaining deliverables are scheduled to be released in 2015.
Of particular interest is Action 13, which calls for a re-examining of transfer pricing documentation. The overall goal for changing transfer pricing documentation is to enhance transparency, certainty, and predictability for both tax administrators and taxpayers. These changes favor the tax administrators, as they will assist with transparency regarding risk assessments and audits. The guidance acknowledges, however, that tax authorities should consider the time and cost incurred by MNEs to comply with the new documentation standards. In an effort to address this concern, Action 13 includes a standardized approach across jurisdictions, whereby taxpayers will disclose consistent and transparent information regarding transfer pricing positions, while providing tax administrators the necessary information needed to allocate resources for transfer pricing risk assessments and transfer pricing audits (commonly referred to as "Country by Country Reporting" or "CBCR"). Three documents are necessary for effective transfer pricing documentation: the Master File, the Local File, and the Country by Country File.
The Master File is intended to provide a high-level overview for a global understanding of the business or businesses of the MNE. The Master File includes the following five pieces of information:
- The MNE group's organizational structure
- A description of the MNE's business or businesses
- An overview of the MNE's intangibles
- An overview of the MNE's intercompany financial activities
- The MNE's financial and tax positions
The Local File provides more detailed information related to specific intercompany transactions according to the jurisdiction in which the income arises. The Local File assures that taxpayers have complied with the arm's length principle in each jurisdiction in which it operates. The Local File includes:
- Relevant financial information regarding transactions or transactions in that specific jurisdiction
- A comparability analysis
- A selection and application of the most appropriate method
Country by Country File
The Country by Country File is an aggregate of the allocation of income across the jurisdictions in which the MNE does business. The Country by Country file provides taxing authorities with high-level information to perform transfer pricing assessments. The Country by Country File guidance suggests inclusion of the following items for all global taxpayers of the MNE group:
- Amount of revenue
- Profit before income tax
- Income tax paid/accrued
- Total employment
- Retained Earnings
- Tangible Assets
- Related party transactions
- Amounts involved in related party transactions
- Company analysis of the transfer pricing determinations
The OECD and G20 Countries have made recommendations to assist tax administrators in terms of approach to documentation contents, deadlines, materiality, penalties, and compliance incentives. While these recommended compliance measures are not yet in force worldwide, some countries are seeking to quickly adopt the guidance, while many others are evaluating timing of adoption or customizing local requirements around the guidance provided by the OECD and G20 Countries.
Both the United Kingdom and Australia, as summarized below, are examples of jurisdictions that have been quick to adopt and react to the publishing of the OECD's guidance on documentation and CBCR. We anticipate continued activity as many other taxing authorities worldwide also evaluate how to adopt the BEPS transfer pricing documentation guidance or use the guidance to develop their own local requirements. While the guidance acknowledges the importance of considering the time and expense burden on taxpayers, we anticipate the local interests of individual countries will lead to a broad array of unique, localized modifications to the BEPS model for transfer pricing documentation. Ultimately, variance from the guidance will place a large compliance burden on taxpayers, making it difficult to coordinate consistent methodologies and data gathering approaches across its global finance and accounting function.
Companies already preparing transfer pricing documentation will be more prepared than those that have not done so. Many MNEs will need to develop processes across their global group to coordinate the gathering and documenting of extensive business, financial, human resources, and related party transactional information that may not be included in their current documentation process.
The initial Action Plan on Base Erosion and Profit Shifting and Action 13 Deliverable: Guidance on Transfer Pricing Documentation and Country-by-Country Reporting can be found on the OECD website.
The United Kingdom ("UK") recently published draft legislation to adopt the CBCR template developed by the OECD. The legislation, which is included in Finance Bill 2015, introduces new statutory requirements for UK-parented MNEs. Under this legislation, UK-parented groups will be required to submit an annual CBCR template to HM Revenue & Customs ("HMRC") disclosing the following data points for each tax jurisdiction in which they operate:
- The amount of revenue, profit before income tax, and income tax paid and accrued;
- Total employment, capital, retained earnings, and tangible assets; and
- Identification of each entity within the MNE group doing business in a particular tax jurisdiction, including business activities within a selection of broad areas in which each entity is engaged.
The CBCR template will help HMRC to better assess international tax avoidance risks and decide whether to initiate a transfer pricing audit. The obligation to file a CBCR will be introduced in two stages. At the initial stage, regulations regarding the scope and detail of the filed template will be proposed. In the second stage, the proposed regulations will be put into effect once the OECD concludes how the reports should be filed and how the included information may be shared among countries. Once the Queen has formally assented to the Finance Bill 2015 approved by Parliament, the regulations will go into effect. The effective date is expected to be January 1, 2016.
Last November, the Australian Taxation Office ("ATO") released Taxation Ruling ("TR") 2014/6, which provides guidance on the reconstruction provisions in the new transfer pricing law. The law requires arm's length conditions to be identified, consistent with the 2010 OECD Transfer Pricing Guidelines. The TR requires consideration of whether arm's length parties are acting in their own best interests by maximizing the overall value of the economic resources they have readily available to them. Arm's length parties should compare all options realistically available to them before entering into that type of related party transactions or arrangements. One arm's length option for such an entity may be to not enter into the transaction or arrangement. Specifically, the 2010 OECD Guidelines include the following two exceptions to the policy of recognizing a transaction or arrangement as actually undertaken and structured:
- The economic substance of the transaction or arrangement differs from its form, or
- Independent enterprises behaving in a commercially rational manner in comparable circumstances would not have characterized or structured the transaction or arrangement in this manner; therefore arm's length pricing cannot reliably be determined.
MNEs that operate in Australia should consider the effects of the reconstruction provisions on their businesses. Companies should self-assess their positions and prepare documentation to support their view on whether the reconstruction provisions apply. If done correctly and submitted prior to filing the tax return, the company will be eligible for penalty protection.
In December 2014, the ATO finalized its guidance on transfer pricing documentation and penalties under the new transfer pricing regime. Final guidance was issued on transfer pricing documentation (TR 2014/8), penalties under the new rules (PS LA 2014/2), and the simplification of the record keeping of the transfer pricing documentation (PS LA 2014/3).
The guidance will provide exemptions from preparing transfer pricing documentation for certain categories of taxpayers and transactions. The details and eligibility criteria were published in January in an online guide. This guide states that the ATO will not review a taxpayer's transfer pricing records beyond confirming the taxpayer's eligibility if certain safe harbor requirements are met. These safe harbors are eligible to small taxpayers, distributors, intragroup services, and low-level intragroup loans. Taxpayers wishing to be eligible for penalty protection should ensure their transfer pricing documentation meets the new requirements.
If you need assistance with assessing your transfer pricing documentation, contact your local CBIZ MHM tax advisor who will put you in touch with one of our transfer pricing specialists.
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