By Tom Lickess, Line of Service Lead, Tax Advisory, Radius
In 2016, we published a post summarizing the Organization for Economic Cooperation and Development’s country-by-country reporting (CbCR) guidelines, which had been released the year before. Most of the information in that post is still useful and current, but we’ve officially moved into a new reality in which CbCR and more detailed local requirements are being passed into law.
As a result, many multinational enterprises (MNEs) must now adhere to new, stricter reporting obligations related to their transfer pricing practices. As we’ll see, MNEs with consolidated group turnover generally greater than US$50 million now have local notification, reporting and documentation requirements. These requirements are being unilaterally implemented by tax authorities around the world, and specific thresholds and deadlines vary by country. MNEs may find themselves falling foul of these new CbCR local requirements, and must be aware of the significant risks of related penalties and tax audits.
The new country-by-country reporting requirements are part of a comprehensive program initiated by OECD and G20 countries to address base erosion and profit shifting, or BEPS. As the OECD explains: “BEPS refers to tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity. Although some of the schemes used are illegal, most are not. This undermines the fairness and integrity of tax systems.”
It’s important to emphasize that the implementation of the OECD’s BEPS program is not limited to OECD and G20 countries. Those bodies have developed the so-called Inclusive Framework on BEPS, which (as of this writing) has more than 100 member countries and jurisdictions, including developing countries. These member countries are “establishing a modern international tax framework under which profits are taxed where economic activity and value creation occur,” and they are “implementing and applying [BEPS] rules in a consistent and coherent manner.”
Inclusive Framework members must implement four BEPS minimum standards, which are subject to peer review to ensure accurate and timely implementation and, as the OECD puts it, “safeguard the level playing field.” The four minimum standards relate to: committing to transparency and information exchange (BEPS Action 5); preventing the granting of treaty benefits in inappropriate circumstances (Action 6); facilitating treaty-related dispute resolution (Action 14); and implementing revised standards for transfer pricing documentation, including country-by-country reporting (Action 13), which is of course the subject of this post.
BEPS Action 13, Country-by-Country Reporting Overview
The new country-by-country reporting requirements being implemented by tax authorities around the world are of critical interest to MNEs. Many former and existing tax laws have more readily enabled profit shifting by effectively isolating tax data. Basically, tax authorities in any given country have had little to no insight into transactions between linked companies of a single multinational group, where those transactions have had no direct relevance to their own tax base. The new requirements seek to make the global operations and the financial and tax positions of multinational groups transparent to tax authorities everywhere.
In 2015, the OECD recommended that the new CbCR requirements should be implemented for fiscal years beginning on or after January 1, 2016, and should apply to MNEs with annual consolidated group revenue equal to or exceeding 750 million euros or near equivalent in domestic currency. (As we’ll see, however, some countries have implemented much lower group revenue thresholds that multinationals and their subsidiary entities must be aware of.)
Under BEPS CbCR guidelines, a parent company must file new CbC reporting documentation in its home country, providing an overview of where profits, sales, employees and assets are located and where taxes are paid and accrued. The home-country tax authorities in turn share the information with tax authorities in other jurisdictions where the multinational group operates. This information collection and sharing “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 automatic exchange of CbCR information is set to go into effect for all participating jurisdictions in June 2018. In December 2017, the OECD announced that — six months in advance of the June deadline — “there are now over 1,400 automatic exchange relationships in place among jurisdictions committed to exchanging CbC Reports … [reflecting] the commitment of BEPS Inclusive Framework members from all corners of the world to the fight against base erosion and profit shifting.”
Documentation and Filing Requirements
BEPS Action 13 calls for a three-tiered approach to transfer pricing documentation consisting not just of a country-by-country report, but also of a master file and a local file. Below are some details on each tier, taken from the OECD’s Action 13 Final Report.
- Master File. The master file provides an overview of the MNE group business, including the nature of its global business operations, overall transfer pricing policies and global allocation of income and economic activity. The master file is meant to place the MNE group’s transfer pricing practices in their global economic, legal, financial and tax context. The taxpayer presents the master file for the MNE group as a whole. The master file “is to be available to all relevant tax jurisdictions.” That is, all of the MNE group’s local country affiliates should retain the master file and in some cases submit it to local tax authorities.
- Local File. The local file provides more detailed information on specific intercompany transactions than the master file. It is intended to supplement the master file and provide assurance that the taxpayer has complied with the arm’s length principle in its transfer pricing positions related to a specific jurisdiction. The local file provides information on material transactions between a local country affiliate and associated enterprises in different countries. In some cases, the local-file requirement can be satisfied by a specific cross-reference to information in the master file. The file should be retained at the local affiliate level and in some cases submitted to local tax authorities.
- Country-by-Country Report. The country-by-country report provides information on the global allocation of income, taxes paid and certain indicators of the location of economic activity among tax jurisdictions where the MNE group operates. The CbCR also provides the MNE’s number of employees, stated capital, retained earnings and tangible assets in each tax jurisdiction. Finally, it identifies each entity within the MNE group doing business in a tax jurisdiction and indicates the business activities that each entity is engaged in. The parent company must file CbCR documentation in its home country.
Introduction of Lower Revenue Thresholds by Some Countries
As mentioned, OECD guidance indicates that MNE groups with annual consolidated group revenue of less than 750 million euros (or near equivalent in domestic currency) are exempt from filing CbCRs. Multinationals must be aware, however, that many countries have much lower group revenue thresholds that trigger local documentation and reporting requirements.
Moreover, in the majority of advanced countries, these requirements are not limited to the parent entity. Many countries have now implemented local master file and local file documentation and reporting requirements for local country affiliates that are part of an MNE group with annual consolidated group revenue of less than 750 million euros, in some cases as low as US$50 million. In addition, some countries (such as Germany and Mexico) have requirements based on local turnover thresholds.
The challenge here for MNEs is that these rules are being unilaterally implemented on a country-by-country basis, with different revenue thresholds, notification and documentation requirements, and deadlines.
What Multinationals Need to Consider
Multinational organizations must be aware that each country has its own transfer pricing documentation and reporting requirements and deadlines, and that requirements are changing rapidly all over the world.
Many of these country-specific requirements are strongly influenced by OECD BEPS guidelines, but they don’t necessarily precisely align with them. Certainly, no multinational should assume that its transfer pricing obligations won’t change simply because its annual consolidated group revenue is less than 750 million euros.
As a rule of thumb, multinationals with consolidated group revenue of 750 million euros or more will have to fulfill requirements based on the three-tiered approach outlined above, including the parent company submitting CbC reporting documentation in its home country. Those multinationals with consolidated group revenue of US$50 million or more will also likely have to fulfill local master file and local file documentation and reporting requirements for each of its local country affiliates.
MNEs should also ensure that they remain appropriately advised as to the ongoing changes of their CbCR obligations. More and more countries are updating their transfer pricing requirements, and the rules for those early adopters continue to change. Failure to comply will at best lead to penalties and at worst lead to tax audits and the administrative burdens of explaining and defending group transfer pricing positions in the absence of appropriate documentation.