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Transfer Pricing: BEPS And New Documentation Requirements
June, 06th 2014

Successive surveys of tax executives and senior finance professionals at multinational companies show that risks associated with transfer pricing have become the number one tax-related concern for businesses operating across several jurisdictions.

Ernst and Young's (EY's) latest Global Transfer Pricing Survey shows that businesses are taking increasing heed of global headlines on multinationals' tax affairs, with EY finding that, overall, 66 percent considered risk management their most pressing issue, up 32% from the same survey conducted in 2010.

The report also finds that companies are experiencing a significant increase in unresolved transfer pricing examinations and facing increased penalties and interest when tax authorities formulate assessments.

Nearly half of the survey respondents (47%) reported experiencing double taxation as a result of a transfer pricing audit. Twenty-four percent of parent companies reported being subject to tax penalties in the past three years, in comparison with 19% in the 2010 survey and 15% in a 2007 edition of the survey. Sixty percent of parent companies are also paying interest charges as a result of transfer pricing adjustments.

One reason for this is that revenue authorities across the world have been policing the area of transfer pricing more proactively over the past couple of years, leading to a situation where companies are more likely to face transfer pricing audits, which can result in heavy non-compliance penalties and protracted and expensive administrative and legal proceedings. This is unsurprising perhaps given the added pressure being placed on tax departments in many countries to increase the amount of tax they are collecting.

Another reason why transfer pricing has become a major area of tax risk for multinationals is because transfer pricing laws, regulations and requirements vary hugely from one jurisdiction to another. While most developed countries for example have fairly sophisticated transfer pricing regimes in place, supported by tax officials with the requisite knowledge of international taxation, emerging and developing economies are well behind the transfer pricing curve, with many only recently having put in place new transfer pricing regimes. Indeed there is a sense in many developing countries that tax authorities are making up their transfer pricing rules up as they go along. For instance, at a recent meeting of the American Bar Association's Section of Taxation in Phoenix, which focused on West African countries and extractive industries, it was observed that many auditors in the region fail to understand basic transfer pricing concepts. It was also found that multinationals generally cannot rely on advance rulings or advanced pricing agreements in West Africa.


This is a situation which benefits neither taxpayers, nor the authorities themselves, which is why transfer pricing is at the heart of the OECD's Action Plan on base erosion and profit shifting (BEPS), released to coincide with the G20 Summit in Moscow in July 2013. Indeed, five out of the 15 actions specified in the Action Plan are concerned with transfer pricing issues in one way or another: Action 4 seeks to limit base erosion via interest deductions and other financial payments; Actions 8,9, and 10 aim at developing transfer pricing outcomes that are in line with value creation in the areas of intangibles, risks and capital, and other high-risk transactions; and Action 13 seeks to develop new rules regarding transfer pricing documentation to enhance transparency while balancing this need against costs to businesses.

The preamble to Action 13 states that: "The rules to be developed will include a requirement that MNE's 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."

The remainder of this article looks at the OECD's Discussion Draft on Action 13, and the response from the business community and other stakeholders to its proposals.

Country-by-Country Reporting

As part of a series of BEPS-related consultations, on January 30, 2014, the OECD released its Discussion Draft on Transfer Pricing Documentation and Country-by-Country Reporting, designed to update Chapter V of the OECD Transfer Pricing Guidelines, adopted back in 1995.

As a rule, the OECD's position is to expect taxpayers to take reasonable steps to have arm's length prices at the time the transaction is made. Contemporaneous documentation should be ready no later than the deadline for filing the corporation tax return. However, in its proposals, the OECD has suggested a two-tier standardized format on transfer pricing documentation. The idea is to have a master file and a local file. Under the proposals, the master file would be in English while the local file could be in the local language.

The master file would provide an overview of the MNE, outlining notably: (1) the MNE's organizational chart; (2) a description of the MNE's activities; (3) the MNE's intangibles; (4) the MNE's intra-group financing operations; and (5) the MNE's "financial and tax positions". This latter section should include: (1) consolidated financial statements; (2) any applicable APAs or Advance Rulings; (3) other tax rulings in relation to transfer pricing; (4) current or recently resolved MAP matters; and (5) a country-by-country reporting template.

The country-by-country template is provided for by Annex III. It is essentially designed to specify some basic items of financial data, such as equity; revenues; total payroll expenses; number of employees; book value of tangible assets; EBIT; income and withholding taxes paid; and certain intra-group payments (inbound and outbound), such as service fees, interest, and royalties.

On the other hand, the contents of the local file are specified by Annex II. Most importantly, the local file would need to include a detailed transfer pricing study, a group organization chart, as well as the taxpayer's financial statements. In addition, the OECD suggests requiring taxpayers to explain the potential impacts of any business restructuring made in the previous year.

The OECD's ultimate goal is to keep transfer pricing compliance costs in check while ensuring a higher level of information available to tax authorities. Essentially, taxpayers should not be penalized if they take reasonable steps to provide documentation. Taxpayers should not be required to bear excessive costs solely to find comparable data when there is none. Tax authorities should permit all transfer pricing documentation formats (electronic or paper-based), as long as they are readily accessible. Simplified transfer pricing compliance procedures should be considered for SMEs. Transfer pricing documentation should not be required to be certified, nor should it be expected to be prepared by consultancy firms when that work can be done in-house.

Regarding updates, the data for existing comparables should be updated at least every year. However, the OECD advises tax authorities to review searches for comparables every three years only, providing the market conditions aren't subject to much variation.

Finally, the OECD made clear that the burden of proof should be shifted to the taxpayer, as it would make non-compliance much costlier. Where there is already such a thing, penalties on underpaid tax should be reduced if the taxpayer has timely and duly fulfilled its transfer pricing documentation obligations.

The burden of proof issue often plays a critical part in transfer pricing cases. As a result, the OECD's proposals regarding this matter would constitute a revolution in many jurisdictions.

Reaction to CbC Reporting

Reaction to the CbC proposals from the business and tax practitioner communities has been mixed. While many respondents support the need for more transfer pricing transparency and harmonisation in principle, the consensus that has emerged is that the OECD's plan will place an unacceptable cost burden on taxpayers.

PwC for example doubts the OECD's dual objective will be achieved. While the OECD said it is looking forward to reducing compliance costs for businesses at the same time as increasing the level of information available to the tax authority, PwC points out that the OECD has focused its attention on helping tax authorities rather than businesses.

PwC criticised the two-tiered approach suggested by the OECD, namely the master file/local file divide. Most importantly, the master file would essentially come in addition to existing country-specific documentation requirements. A higher compliance burden would be the likely outcome of the OECD's proposals.

The master file was said to pave the way to transfer pricing adjustments based on unitary taxation, which could in turn lead to further mismatches from one country to another. Double taxation would probably result in many instances. Furthermore, the master file would require some files to be translated from English to the local language and vice versa, which is costly.

There are also serious concerns regarding the protection of confidential information. This is essentially because taxpayers may have genuine business reasons not to display such information to all their group members. As a result, it is suggested to maintain reliance on the traditional tax information exchange agreements.

According to PwC, the proposed CbC reporting requirements would go significantly beyond current practice. Most importantly, they would require new information that is costly for taxpayers to gather while being of limited use to tax auditors. Some of this information may not be available to taxpayers at all, such as data about the 25 highest paid executives. As regards information about payments of service fees, interest and royalties, this requirement could expose companies to unnecessary transfer pricing controversies, for instance in connection with transactions between unrelated parties.

The OECD's suggested timing for CbC reporting has been criticized as well, for the deadlines may be too tight, even with the OECD's proposed extension to one year after the parent company's year-end.

In a 15-page response, the Confederation Fiscale Europeenne (CFE), endorsed the need to enhance the level of information available to tax authorities, but warned that compliance costs for multinational enterprises (MNEs) should be kept as low as possible. Ultimately, documentation requirements should be clear, fair, and designed to ensure a level-playing field between businesses, it said.

The CFE has put forward a number of recommendations for consideration by the OECD, including that:

Data should be collected through a common template, and the extent of information required should be the minimum required for risk assessment purposes;
Penalties, if any, should be as low as possible to ensure that MNEs comply with the arm's length principle and duly prepare documentation. The CFE called for the OECD to provide more detailed guidance in this area;
Tax authorities should consider relying on Tax Information Exchange Agreements (TIEAs) to obtain information that local taxpayers do not have access to, e.g. for confidentiality reasons, and penalties should not be imposed in such cases;
Transfer pricing documentation requirements should not vary from one country to another;
The timing to prepare documentation should not be disproportionately stringent;
Any "specific" information requested by tax authorities should be strictly confidential;
Tax authorities should be encouraged to share their risk assessment results with taxpayers to ensure constructive dialogue;
Safe harbor provisions could be introduced for Small and Medium-sized Enterprises (SMEs); and
The OECD should clarify how tax authorities should use the CbC reporting template, especially with regard to intangibles, in order to avoid adjustments based on global formulary apportionment.
The CFE has also made specific comments on the master file and local file proposed by the OECD and their structures, about the information that should be requested, and on the persons in multinational groups who will be responsible for maintaining these files.

The CbC proposals have also raised concern among tax authorities. Speaking at a conference on February 10, 2014, HM Revenue and Customs's Deputy Director in charge of Transfer Pricing, Peter Steed, said that the Draft goes "beyond what governments need for transfer pricing risk assessment." Steed said that the OECD's proposals will disproportionately disadvantage businesses in the UK in the light of HMRC's information needs. "The UK position is that there should be more balance," he said.

Many have also expressed concern about the future of the arm's length principle. This is essentially because Country-by-Country (CbC) reporting would likely pave the way to unitary taxation of multinationals. At least for now, tax authorities seem particularly willing to obtain holistic information about multinationals, practitioners from the UK, Australia, India and the US have said, but there remains uncertainty about the long-term impact of these increased disclosures on the functioning of the arm's length principle.

Robert Stack, US Treasury deputy assistant secretary (international tax affairs), said that the arm's length principle, as it currently stands, leads to outcomes that the US Treasury doesn't "like as a policy matter." Stack favors relaxing the arm's length principle to ensure that profit is not shifted to a country in which a company has little physical presence. He also expressed concern that the CbC reporting template would pose confidentiality risks.

"We tend to favor the government-to-government exchange for reasons of confidentiality," he explained.

The Next Steps

The BEPS Action Plan is to be finalised in three phases: September 2014, September 2015 and December 2015. The OECD hopes to conclude its work on Action 13 and confirm the necessary changes needed to transfer pricing rules in relation to documentation requirements by the first of these three deadlines. Changes to the transfer pricing rules in relation to risks and capital, and other high-risk transactions (Actions 9 and 10) are due to be finalised by September 2015, with changes to the transfer pricing rules to limit base erosion via interest deductions and other financial payments (Action 4) set to be agreed by December 2015.

It remains to be seen whether the OECD will deliver on this ambitious timetable which seeks changes to international tax principles that have been established for decades in the space of a couple of years. Commentators suggest that the project has sufficient political backing from the developed nations to enable it to be seen through, but the danger is that individual jurisdictions will act unilaterally on the recommended changes, thus making the world of international taxation a more uncertain and risky place for multinationals to operate in.

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