B y now, most if not all of us have heard about the

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1 Daily Tax Report Reproduced with permission from Daily Tax Report, 216 DTR J-1, 11/09/2015. Copyright 2015 by The Bureau of National Affairs, Inc. ( ) Information Reporting Kimberly Tan Majure and Monica Zubler of KPMG look at country-by-country reporting requirements under the OECD s base erosion and profit shifting program, and at questions multinational groups face in characterizing partnerships and entities that have made U.S. check-the-box elections. It doesn t take long for the difficulties posed by partnerships to play out on the CbyC report, the authors write. Country-by-Country Reporting: Is a Partnership a Corporation by Any Other Name? BY KIMBERLY TAN MAJURE AND MONICA ZUBLER B y now, most if not all of us have heard about the Base Erosion and Profit Shifting, or BEPS, initiatives launched by the Group of 20 (G-20) and the Organization for Economic Cooperation and Development (OECD). The BEPS project was driven by a sense that the existing framework of international tax standards is inadequate to address perceived abuses by multinational enterprises (MNEs), particularly in a world with increasing economic integration. At heart, BEPS represents a sea change in the way companies approach international tax planning. Historically, a good international tax director or adviser would structure a multinational company both in Kimberly Tan Majure is a principal in the International Group of KPMG s Washington National Tax practice, and is national lead for Country-by-Country Reporting. Monica Zubler is a senior manager in the International Group of KPMG s Washington National Tax practice. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. This article represents the views of the authors only, and does not necessarily represent the views or professional advice of KPMG LLP. terms of entities and operations in a way that was most tax efficient from an overall global perspective. Among other things, elements of a comprehensive international tax plan would generally include: s maximizing income recognition in lower tax jurisdictions, while maximizing deductions in higher tax jurisdictions (quite possibly using intercompany transactions to do so); s taking advantage of preferential tax regimes and other local tax benefits; s implementing hybrid financial instruments and entities to create tax arbitrage opportunities; and s structuring foreign operations to avoid taxable permanent establishment status. In large part, this planning was made possible by the inherent inconsistencies among individual jurisdictions differences in timing, character and choices regarding fiscal protectionism versus competition for inbound investment and limited visibility of one jurisdiction into inconsistencies with another. By acting collectively to enact coordinated standards and develop mechanisms for sharing information, the OECD and G-20 countries believe they can eliminate some of the opportunities for tax arbitrage that exist in the current framework, and better match the location of profits and taxation with that of an enterprise s economic value drivers. After months of discussion and negotiations, the OECD/G-20 BEPS project recently published final reports articulating 15 actions to accomplish these objectives. COPYRIGHT 2015 BY THE BUREAU OF NATIONAL AFFAIRS, INC. ISSN

2 2 Among other things, the BEPS Action Plan items include neutralization of hybrid instruments, limitations regarding preferential tax regimes, expansion of treaty permanent establishment concepts, and greater visibility and consistency among jurisdictions with respect to transfer pricing. Reporting Critical to Project A critical component of the BEPS Project and the element that is likely to impact MNEs first is the country by country (CbyC) reporting set forth in Action As part of the effort to increase global transparency, countries have committed under Action 13 to require large MNEs to file an annual CbyC report, and provide jurisdiction-specific data on where they generate related and unrelated operating revenue and pre-tax profits, and accrue and pay income tax. MNEs would also disclose the jurisdictions where they maintain tangible assets, head count and capital, and where they accumulate earnings. Ultimately, the CbyC data is expected to guide foreign tax and, when matched up with new master and local filing packages, transfer pricing audits. An MNE group s ultimate parent entity (or, if the parent isn t subject to CbyC filing requirements in its country, a chosen surrogate entity) would file the CbyC report in the jurisdiction where it resides, and the disclosed information would be shared with other jurisdictions via automatic exchange of information mechanisms pursuant to treaties or tax information exchange agreements. Ultimately, the CbyC data is expected to guide foreign tax and, when matched up with new master and local filing packages, transfer pricing audits. The final report on Action 13 includes templates for capturing the required information, as well as general and specific instructions and model implementing legislation. As with the proposed templates published in July 2014 (as part of the 2014 Report ), the final CbyC report template contains three tables: s Table 1 shows jurisdiction-specific information regarding the items described above (revenues, profits before taxes, taxes, etc.). s Table 2 requires a listing of all Constituent Entities in the group by country, along with a high level indication of their main activities. s Table 3 is an open-ended narrative for filing entities to provide more detail regarding their operations 1 See OECD/G20 Base Erosion and Profit Shifting Project: Transfer Pricing Documentation and Country-by-Country Reporting, Action Final Report ( Action 13 Final Report ). and activities, and otherwise flesh out the raw data presented in the first two tables. Along with the reporting template, the OECD published high level instructions. A mere four pages in length, the instructions provide very limited practical guidance on how the tables are to be completed. With initial filings anticipated no later than Dec. 31, 2017, 2 MNE groups are starting to prepare dry run CbyC reports. MNEs want to be sure they put their best feet forward on their initial filings, particularly as changes in data or approach including reasons for and effects of any changes would need to be flagged in future reports. 3 With scant OECD instructions and ahead of Internal Revenue Service guidance, however, MNEs are inevitably running into issues in preparing their dry run reports. Partnership Confusion One cause of significant confusion is the intended treatment of, and disclosures in relation to, U.S. and foreign partnerships. The Action 13 instructions take a business unit approach with respect to the identification of Constituent Entities. Similar to the U.S. concept of qualified business unit, 4 the term Constituent Entity sweeps in companies, corporations, partnerships, trusts and even taxable branches/permanent establishments that are included in the consolidated financial statement reporting group of the reporting entity. 5 Once included within the group, Constituent Entities data must be included on the group s CbyC report. The inclusion of partnerships as Constituent Entities makes sense conceptually. Partnerships are formed to pursue business activities, and are as capable of conducting an economic enterprise as corporations. As a practical matter, however, partnerships and corporations may be reflected very differently on the CbyC re- 2 Action 13 Final Report, Chapter V.E.2.1. (para. 50) ( It is recommended that the first Country-by-Country Reports be required to be filed for MNE fiscal years beginning on or after 1 January Given the recommendation in paragraph 31 that MNEs be allowed one year from the close of the fiscal year to which the Country-by-Country Report relates to prepare and file the Country-by-Country Report, this recommendation means that the first Country-by-Country Reports would be filed by 31 December ). MNE groups having a fiscal year ending on a date other than 31 December would be able to file their first report later in 2018, but no later than 12 months after the close of the relevant MNE fiscal year. Note, a U.S. Treasury official has suggested that the IRS may require businesses to file their CbyC reports with their U.S. tax returns three months earlier than the OECD recommendation. See 2015 TNT U.S. May Set CBC Report Deadline Earlier Than OECD. (Release Date: June 12, 2015) (Doc ). 3 Action 13 Final Report, Chapter V, Annex III (B), p. 32 ( If a change is made to the source of data used from year to year, the Reporting MNE should explain the reasons for the change and its consequences in the Additional Information section of the template. ). 4 Section 989 of the Internal Revenue Code of 1986, as amended. 5 Note, the Action 13 Final Report didn t include an illustrative list of specific entities such as the one included in the definition of Constituent Entities in the July 2014 Report. However, the definition of Constituent Entity hasn t changed and, consequently, we don t view the omission of the examples of Constituent Entities as a substantive modification COPYRIGHT 2015 BY THE BUREAU OF NATIONAL AFFAIRS, INC. DTR ISSN

3 3 port. This is because the CbyC instructions are based not on the concept of Constituent Entities, but on the principles of tax residence. Back in the 1990s, the OECD struggled to apply tax residence principles to fiscally transparent entities, including partnerships, in the treaty context. At a high level, the OECD s conclusion (which was ultimately incorporated into the OECD Model Treaty and related Commentary) was that tax residency at least for treaty purposes should only apply to partnerships that under the laws of that State, [are] liable to tax therein by reason of [their] domicile, residence, place of management or any other criterion of a similar nature. 6 The OECD s work on fiscally transparent entities informs current views regarding partnerships: Aside from relatively rare taxable partnerships (e.g., a Maltese partnership en commandite or a Dutch open CV (a commanditaire venootschap)), a partnership generally is understood not to have a tax residence. A partnership may have a balance sheet, and may conduct a business and even receive revenues, but its tax items aren t its own. From the tax perspective, the real action happens at the partner level. It doesn t take long for the difficulties posed by partnerships to play out on the CbyC report. Table 1 begins with Column 1 listing tax jurisdictions in which the MNE group has Constituent Entities resident for tax purposes. In addition, the instructions provide that a separate line should be included for all Constituent Entities in the MNE group determined not to be tax resident in any jurisdiction. As discussed above, because partnerships are generally not considered to be tax resident anywhere, they appear to fall into the no country of residence box (which we will refer to as having Stateless status). Once the country-specific (including Stateless ) rows of Table 1 are established, MNE groups proceed to fill out data pertaining to the entities in each jurisdiction. Here is where things get a little trickier. The instructions in the Action 13 Final Report ( Final Instructions ) emphasize the importance of a consistent approach to the presentation of data. However, the instructions governing each item to be reported on Table 1 aren t entirely uniform. Moreover, the Constituent Entity concept seems to treat partnerships as entities, but tax residence is often applied to partnerships under an aggregate approach. This mix of concepts raises a host of confusing issues. The confusion starts with the reporting of revenues (Columns 2-4), which are to be reported for all the Constituent Entities... in the relevant tax jurisdiction. 7 It is unclear what that means for partnerships; partnership revenues could arguably be reported as in the jurisdiction where the partnership was formed or where it is managed, or possibly default to Stateless status. In contrast, profits before tax (PBT) and income taxes paid and accrued, as well as all other items, are to be reported by line for all the Constituent Entities resident for tax purposes in the relevant tax jurisdiction. 8 6 See OECD Model Tax Convention on Income and on Capital 2010, Article 1(4), Commentary on Article 1 Note 5. 7 Action 13 Final Report, Chapter V.E.2.1. (para. 50); Annex III(C), p Action 13 Final Report, Annex III (B), p. 31; Annex III(C), p. 33. Assuming the difference in language means something, the partnership doesn t appear precluded from claiming the revenues at the partnership level and reporting them with respect to the jurisdiction in which the partnership is organized or is operating. In contrast, as tax residence is the required condition for reporting other pieces of data, and as partnerships generally aren t tax resident in any jurisdiction, the remaining items are at risk of all being reported as Stateless. The real question is whether any of the partnership items could be treated as flowing up to the partners, as would generally be the case when determining ownership of partnership items (e.g., income and expenses) for tax purposes. If the partnership were viewed as a pure flow-through (i.e. if it were treated as an aggregate of the partners), PBT and income taxes could all be reportable at the partner level. In contrast, if the partnership were viewed as an entity (which would be consistent with its status as a Constituent Entity) these items would be recorded at the partnership level, and remain Stateless. To add one more twist, query whether, if income is received by a fiscally transparent partnership and liability for taxes arises at the partner level, PBT and income taxes must be reported at the partner level regardless of whether an entity or aggregate approach is applied to the partnership. Let us make this a little more concrete with a simple example, illustrated here: US1 and US2, two U.S. corporations, form a U.K. partnership (UKP). UKP earns foreign source royalty income subject to a 5 percent non-u.k. withholding tax. Assuming that UKP isn t liable for tax in the United Kingdom, and that it doesn t otherwise create a U.K. permanent establishment, it doesn t trigger a U.K. line on Table 1. Unless it is liable for tax anywhere else in the world (assume not), the partnership is designated as Stateless. If the IRS interprets the Final Instructions as locating the revenues where the partnership is factually located and assuming there is a United Kingdom line otherwise created on Table 1 the revenues could arguably be reported in the United Kingdom. Otherwise, the revenues seem to be Stateless. As noted above, head count, capital, accumulated earnings and assets could also be treated as Stateless under an entity theory of the partnership. DAILY TAX REPORT ISSN BNA

4 4 Alternatively, if reporting follows an aggregate theory of partnerships, some or even all of the data could possibly end up reflected as partner-level items in the U.S. What happens with the withholding tax? In this case, assuming that the source country treats the partners as the beneficial owners of the income, the partners would likely be the persons with primary liability for the withholding taxes. Reporting the taxes as related to the partnership even if UKP cash funded them would artificially increase Stateless taxes and decrease U.S. taxes; that doesn t seem right. Reporting the taxes as both Stateless and U.S. amounts seems inappropriately duplicative. The Final Instructions don t directly address the issue, but nonetheless appear to adopt a technical taxpayer approach, by providing that a Country A resident should report tax withheld (presumably at source) on interest earned in Country B. 9 Consistent with this, the right answer appears to be reporting the withholding taxes as related to US1 and US2, and in the U.S. The next question is, how should PBT be reported? Legal liability for the tax and beneficial ownership of the underlying income should logically go hand in hand. If the income taxes are reported at the partner level, it is reasonable to assume that related PBT should be reported there as well as should related revenues. But the extent to which some or all of these items should be reported at the partnership or partner level is simply not clear in the Final Instructions. Only two things are apparent: s Non-taxable partnerships are included as Constituent Entities, and the Final Instructions contain different language for revenues as for the other items. s The OECD didn t explain the rationale behind either of these instructions, nor did it publish clarifying detail. For example, consistent with the instructions published in the 2014 Report, the Final Instructions indicate that corporate dividends should be excluded from shareholder revenues. This makes sense for pinpointing an enterprise s value drivers; if revenues are supposed to arise from operating activities, and if dividends are nondeductible for the payor, then inclusion of dividends distorts the payee s revenue data. Along these lines, dividends from other members of the MNE group are excluded from revenues while interest, royalties and other amounts which are generally deductible for the payor are included in the payee s revenues. The Final Instructions are silent on the treatment of branch profits remittances or partnership allocations but, assuming the partnership is taxable, there should be no reason to distinguish either of them from corporate dividends; all artificially duplicate the MNE group s operating yield and mask the location of its generating Constituent Entity. Without a specific exclusion, however, MNE groups may get the benefit (or, depending on the circumstances, suffer the burden) of reporting the additional revenue. Hybrid Entities Finally, although MNE groups around the world are beginning their CbyC report dry runs, U.S. multinationals face a unique challenge: To what extent, if any, should check-the-box elections be reflected on Table 1? In the absence of IRS guidance, there is no way to be certain whether, and to what extent, an MNE group s CbyC report should reflect the effect of an election. Let us look at a variation of the example above, the foreign hybrid entity, i.e., a corporation for foreign tax purposes that is treated as a partnership for U.S. tax purposes: In order to give life to both of these anomalies, MNE groups may be stuck with illogical results. Presumably the OECD didn t intend to create a form that merely reflects standard choice of entity. BEPS isn t about mandating a classical tax system for the entire world. Reporting partnership items as Stateless may raise eyebrows, but to what end? 10 Absent IRS guidance, it just isn t clear how MNE groups should handle the reporting of partnership items. To complicate matters, even if we assumed a taxable partnership, the Final Instructions still contain glitches between instructions for partnerships versus their corporate counterparts. 9 Action 13 Final Report, Annex III (C), p An alternative if the IRS guidance permitted could be to apply the rules for branches and permanent establishments. Permanent establishments aren t normally viewed as having tax residence in a source country. The Final Instructions, however, provide that permanent establishment data should be reported by reference to the jurisdiction in which it is situated.... It might make sense to apply the same rule to partnerships. That way, there is a clear mechanism for disclosing partnerships and, at least, their revenues and balance sheet items. PBT and related taxes could then be reported at the partner level, consistent with the discussion above. The flaw of this approach is that no Constituent Entity would be left reporting as Stateless, thus rendering the designation superfluous. The only difference between this structure and the one in Example 1 is that UKP is an entity that is liable for U.K. tax on its income. It is only viewed as a partnership (and a passthrough entity) as a result of a U.S. check-the-box election, and then only for U.S. tax purposes. Which controls on the U.S. CbyC report the U.S. tax fiction or the rest-of-world tax perspective? If we adopt the rest-of-world view of this structure, UKP s U.K. tax residence establishes it as a U.K. Constituent Entity and that, in turn, triggers creation of a COPYRIGHT 2015 BY THE BUREAU OF NATIONAL AFFAIRS, INC. DTR ISSN

5 5 U.K. line on Table 1. All of UKP s data is reported as in the United Kingdom, including the 5 percent non-u.k. withholding tax paid on the royalties and any income tax imposed by the United Kingdom. If we adopt the U.S. view, we get different results. This view wouldn t change where UKP is tax resident (the U.K.), but arguably would cause the items to be items of the partners, rather than UKP. Now let us flip things around a little bit and take a look at a reverse hybrid, i.e., an entity treated as a partnership for foreign tax purposes, but as a corporation for U.S. tax purposes: Is there a right answer as to which view should control CbyC reporting? Not necessarily. One could argue that the U.S. tax view, i.e., showing the planning that a U.S. MNE group implemented to manage its target effective tax rate, is the one that the IRS would be more interested in understanding. On the other hand, given that copies of the CbyC report will be provided to other tax authorities under treaty information exchange provisions or pursuant to a tax information exchange agreement, it makes sense to provide information from the foreign (and U.S. non-tax) perspective. Absent specific IRS guidance, the authors believe the foreign tax perspective to be more compelling, in that it permits apples to apples comparisons between U.S. and foreign MNE groups operating in a given jurisdiction. If clear IRS guidance hasn t been issued by the time the initial CbyC reports are due, U.S. MNE groups will need to make judgment calls regarding their Table 1 presentation of the issues discussed above, and should consider disclosing their rationale on Table 3 of the report. The reverse hybrid may actually present the worst of all worlds. That is, the entity isn t taxable anywhere, so is Stateless in any case. From the U.K. tax perspective, UKP s data appears to be split: PBT and related income taxes may be allocated to UKP s partners and reported in the U.S.; revenues are arguably reportable in the United Kingdom; and balance sheet items and head count are reported as Stateless. Under the U.S. view of the world, no items flow up to the U.S. partners, so all data remain Stateless. As these examples illustrate, the issue of whether a U.S. MNE group should reflect the U.S. or foreign tax perspective on its CbyC reports can be highly sensitive. We can only hope that the IRS will address the issue clearly in upcoming guidance. One thing is certain, that MNE groups will be required to take a consistent view among all of their hybrids and reverse hybrids. It may be difficult enough teasing required information out of multiple entities general ledgers, statutory accounts or management accounts much less having to do so with two different organizational charts (U.S. tax and restof-world tax) in mind. Planning Ahead As MNE groups approach the task of creating and filing CbyC reports, they will need to plan ahead. It takes time to trace and compile information through a multinational group particularly one big enough to trigger CbyC filing requirements. 11 MNE groups should be considering not only the practical implications of finding and collating raw information, but also the conceptual issues of characterizing data and the relevant entities, and identifying the jurisdiction(s) to which they relate. They may, in particular, wrestle with their approach to partnerships. Where are partnerships tax residents (if anywhere)? Should they be consistently treated as entities throughout the report, or should MNE groups take an aggregate approach to some or all of partnership data? How should a U.S. reporting entity treat partnerships that are either creations of, or whose treatment is modified for U.S. tax purposes by, check-thebox elections? In structuring and implementing a CbyC reporting plan, what the model instructions don t say is, perhaps, just as important as what they do say. The U.S. Treasury has indicated that CbyC guidance will be issued by the end of the year. 12 Let us hope the guidance also brings us an end to these questions. 11 The Action 13 Final Report, like the 2014 Report, established a 750 million euro ($821 million) revenue filing threshold for MNE groups TNT 198-2, Stack Sheds Light on Coming U.S. CBC Guidance, 10/13/15 (Doc ). DAILY TAX REPORT ISSN BNA