Global Tax Alert. OECD releases report under BEPS Action 13 on Transfer Pricing Documentation and Country-by-Country Reporting.

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1 23 September 2014 EY Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: Services/Tax/International- Tax/Tax-alert-library#date OECD releases report under BEPS Action 13 on Transfer Pricing Documentation and Country-by-Country Reporting Executive summary On 16 September 2014, the Organisation for Economic Co-operation and Development (OECD) released a series of deliverables that address seven of the focus areas in its Action Plan on Base Erosion and Profit Shifting (BEPS). The report released on Action 13 (the Report) contains revised standards for transfer pricing documentation and a template for country-by-country (CbC) reporting, both of which will be included in the OECD Transfer Pricing Guidelines. The Report indicates that the transfer pricing documentation standards and the CbC reporting standards will be revisited by the OECD and G20 countries no later than the end of 2020 to assess whether additional or different data should be required to be reported. The CbC reporting template requires multinational enterprises (MNEs) to report the amount of revenue (related and unrelated party), profits, income tax paid and taxes accrued, employees, stated capital and retained earnings, and tangible assets annually for each tax jurisdiction in which they do business. In addition, MNEs are also required 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 conducts. This information is to be made available to the tax authorities in all jurisdictions in which the MNE operates. The guidance on transfer pricing documentation requires MNEs to include a high-level overview of their global business operations and transfer pricing policies in a master file that also is to be made available to all relevant country tax administrations. Specific information would be required for intangibles and intercompany financial activities. Moreover, the transfer pricing guidance requires

2 that detailed information on all relevant material intercompany transactions be included in a local file in each country to be provided to such country s tax administration. The Report reflects some significant changes from the discussion draft released on 30 January 2014 (Discussion Draft). For example, the CbC reporting template requires information to be reported on a jurisdiction by jurisdiction basis rather than on an entity by entity basis. Moreover, certain detailed information on payments and receipts for intercompany royalties, interest and services is not included in the CbC template, but instead is to be reported in the transfer pricing documentation local file. Furthermore, the CbC report is to be kept separate and is not included as a part of the transfer pricing documentation master file. Additional work will be undertaken by the OECD over the next months with respect to implementation and the approach for filing of the master file and the CbC report. Guidance in this respect is expected to be delivered in early Detailed discussion Overview The Report contains revised guidance on documentation and reporting that will be included in the OECD Transfer Pricing Guidelines as a replacement for the current content of Chapter V. The revised guidance begins with a statement of three objectives of transfer pricing documentation rules and then provides guidance for the development of such rules so that transfer pricing compliance is more straightforward and more consistent among countries while at the same time providing tax administrations with more focused and useful information for transfer pricing risk assessments and audits. The three stated objectives of transfer pricing documentation are to: Ensure that taxpayers give appropriate consideration to transfer pricing requirements in establishing prices and other conditions for transactions between associated enterprises and in reporting the income derived from such transactions in their tax returns Provide tax administrations with the information necessary to conduct an informed transfer pricing risk assessment Provide tax administrations with useful information to employ when conducting a thorough audit of the transfer pricing practices of entities subject to tax in their jurisdiction, although it may be necessary to supplement the documentation with additional information as the audit progresses In order to achieve these objectives, countries should adopt a standardized approach to transfer pricing documentation, to be implemented in their domestic law. The revised guidance suggests a three-tiered structure consisting of a master file, a local file and a country-by-country report, described below. Master file The master file should provide an overview of the MNE group business, its overall transfer pricing policies, and its global allocation of income and economic activity in order to place the MNE group s transfer pricing practices in their global economic, legal, financial and tax context. The Report states that it is not intended to require exhaustive listings of minutiae as this would be both unnecessarily burdensome and inconsistent with the objectives of the master file. In producing the master file taxpayers should use prudent business judgment in determining the appropriate level of detail for the information supplied, keeping in mind the objective of the master file to provide tax administrations with a high-level overview of the MNE s global operations and policies. The use of cross-references to other existing documents, together with copies of the relevant documents, should be deemed to satisfy the relevant requirement. The Report indicates that information is considered important if its omission would affect the reliability of the transfer pricing outcomes. It does not provide more detailed guidance, such as materiality thresholds, on what is considered important. The information required in the master file can be grouped in five categories: (i) the MNE group s organizational structure; (ii) a description of the MNE s business or businesses; (iii) the MNE s intangibles; (iv) the MNE s intercompany financial activities; and (v) the MNE s financial and 2

3 tax positions. Taxpayers should present the information in the master file for the MNE as a whole but organization of the information by line of business is permitted where well justified by the facts. The Report states that where line of business presentation is used, care should be taken to assure that centralized group functions and transactions between business lines are properly described in the master file. The master file differs from typical current documentation standards. It has a global scope and should provide a global overview. A description of the supply chain for the group s largest products and/or service offerings will have to be included. Important transactions with respect to intangibles, financial transactions, and business restructurings must be listed. Finally, the master file should contain a list and brief description of the MNE group s existing unilateral advance pricing agreements (APAs) and other tax rulings relating to the allocation of income among countries. These differences will require companies to review their existing documentation and their process for preparing the documentation. Local file While the master file provides a high-level overview, the local file should provide more detailed information relating to specific material intercompany transactions. The information required in the local file should supplement the master file and help in assessing whether the taxpayer has complied with the arm s length principle in its material transfer pricing positions affecting a specific jurisdiction. Individual country transfer pricing documentation requirements should include specific materiality thresholds that take into account the size and the nature of the local economy, the importance of the MNE group in that economy, and the size and nature of local operating entities, in addition to the overall size and nature of the MNE group. It is recommended that small and medium-sized enterprises (SMEs) should not be required to produce the amount of documentation that might be expected from larger enterprises. However, SMEs should be required to provide information and documents about their material cross-border transactions upon a specific request of the tax administration in the course of a tax examination or for transfer pricing risk assessment purposes. Like the new rules for the master file, the guidance for the local file contains some specific deviations from typical current documentation standards. First, it is clear that a specific local file will have to be prepared, including financial information and allocation schedules to show how the financial data used in applying the transfer pricing method may be tied to the annual financial statements. This implies that generic documentation describing the transfer pricing policy for the group as a whole can be used. Furthermore, the local file should contain a description of the reasons for concluding that relevant transactions were priced on an arm s length basis based on the application of the selected transfer pricing method. A company will need to be able to support that both the transfer pricing policy and the actual results are at arm s length. The local file requires that the reporting amount of intra-group payments and receipts for each category of controlled transactions involving the local entity (i.e., payments and receipts for products, services, royalties, interest, etc.) be broken down by tax jurisdiction of the foreign payor or recipient. It should be noted that the Report refers to payments and receipts and not to consideration charged. The Report indicates that various types of agreements will have to be reported, including all material intercompany agreements concluded by the local entity and copies of existing unilateral and bilateral or multilateral APAs and other tax rulings to which the local tax jurisdiction is not a party and which are related to controlled transactions described above. Like for the master file, these differences will require companies to review their existing documentation and the process to prepare such documentation. Compliance issues The report contains specific guidance with respect to certain compliance issues such as timing and penalties, among others. The Report states that taxpayers should try to determine transfer prices based upon information 3

4 reasonably available at the time of the transaction and should confirm the arm s length nature of their transactions at the time of filing their tax returns. Among the compliance issues listed, several are of specific practical importance for taxpayers. The Report recommends that transfer pricing documentation be periodically reviewed in order to determine whether functional and economic analyses are still accurate and relevant as well as to confirm the validity of the applied transfer pricing methodology. In general, the master file, the local file and the CbC report should be reviewed and updated annually. With respect to database searches for comparables, the Report indicates that these should be updated every three years. However, the financial data for the comparables should be updated every year. The Report further expresses a strong preference for the use of local comparables over the use of regional comparables. The language in which transfer pricing documentation should be submitted should be established under local laws. Countries are encouraged to allow for the filing of transfer pricing documentation in commonly used languages where the usefulness of the documents will not be compromised. Where tax administrations believe that translation of documents is necessary, they should make specific requests for translation and should provide sufficient time. CbC report The Report provides for CbC reporting to be done separately, rather than being included in the master file as was provided for in the Discussion Draft. The final CbC reporting template is divided into three tables: Table I. Overview of allocation of income, taxes and business activities by tax jurisdiction Table II. List of all Constituent Entities of the MNE group included in each aggregation by tax jurisdiction Table III. Additional Information The Report states that the country-by-country report will be helpful for high-level transfer pricing risk assessment purposes. It further emphasizes that such information should not be used as a substitute for a detailed transfer pricing analysis of individual transactions and prices based on a full functional analysis and a full comparability analysis and such information does not constitute conclusive evidence that transfer prices are or are not appropriate. Finally, the Report states that the information should not be used to propose transfer pricing adjustments based on a global formulary apportionment of income. CbC reporting template The ultimate parent of an MNE group of multinational corporations (the Reporting MNE) is to be required to complete a template reporting the allocation of the group s income, taxes and business activities on a tax jurisdiction by tax jurisdiction basis. A Constituent Entity of the MNE group is any separate business unit of the MNE group that is included in the consolidated group for financial reporting purposes. Separate reporting for each permanent establishment is required if it conducts business in a tax jurisdiction and prepares a separate income statement for regulatory, financial reporting, internal management or tax purposes. A permanent establishment should be listed under the tax jurisdiction in which it is situated with a note indicating the associated legal entity. The CbC report covers the fiscal year of the Reporting MNE. For Constituent Entities, at the discretion of the Reporting MNE, the report should reflect on a consistent basis either (i) information for the fiscal year of the relevant Constituent Entities ending on the same date as the fiscal year of the Reporting MNE or ending within the 12 month period preceding such date or (ii) information for all the relevant Constituent Entities reported for the fiscal year of the Reporting MNE. The Reporting MNE should consistently use the same sources of data from year to year in completing the template. It may choose to use data from its consolidation reporting packages, from separate entity statutory 4

5 financial statements, regulatory financial statements, or internal management accounts. The Report states that a reconciliation of the CbC report to the consolidated financial statements is not required. Amounts should be reported in the functional currency of the Reporting MNE, but no adjustment for differences in accounting principles across jurisdictions. A brief description of the data sources used, and any change made in such sources used, should be included in Table III (Additional information). Table I of the CbC template requires the Reporting MNE to provide the following information annually: Tax jurisdiction The required information is to be reported on a tax jurisdiction by tax jurisdiction basis, rather than on an entity by entity basis as provided for in the Discussion Draft. A separate line should be included for all Constituent Entities deemed by the Reporting MNE not to resident in any jurisdiction for tax purposes. Revenues Separate columns are provided for revenues generated from related party transactions, revenues from transactions with related parties, and sum. For this purposes, revenues should include revenues from sales of inventory and properties, services, royalties, interest, premiums and any other amounts derived from transactions with related or unrelated persons. Revenues from payments received from other Constituent Entities that are treated as dividends in the payor s tax jurisdiction are excluded. Profit (Loss) before income tax The sum of the profit (loss) before income tax for all Constituent Entities resident for tax purposes in the relevant jurisdiction. This should include all extraordinary income and expense items. Income tax paid (on cash basis) The total amount of income tax actually paid during the relevant fiscal year by all Constituent Entities resident for tax purposes in the relevant jurisdiction to the residence tax jurisdiction and to all other tax jurisdictions. Taxes paid should include withholding taxes paid by other entities (associated enterprises and independent enterprises) with respect to payments to a Constituent Entity. Income tax accrued (current year) The sum of the accrued current tax expense recorded on taxable profits or losses of the year of reporting of all Constituent Entities resident for tax purposes in the relevant jurisdiction. The current tax expense should reflect only operations in the current year and should not include deferred taxes or provisions for uncertain tax liabilities. Stated capital The sum of the stated capital of all Constituent Entities resident for tax purposes in the relevant jurisdiction. With regard to permanent establishments, the stated capital should be reported by the legal entity of which it is a permanent establishment unless there is a defined capital requirement in the permanent establishment tax jurisdiction for regulatory purposes. Accumulated earnings The sum of the total accumulated earnings of all Constituent Entities resident for tax purposes in the relevant jurisdiction as of the end of the year. With regard to permanent establishments, accumulated earnings should be reported by the legal entity of which it is a permanent establishment. Number of employees The total number of employees on a full-time equivalent basis of all Constituent Entities resident for tax purposes in the relevant jurisdiction. This may be reported as of the year-end, on the basis of average employment levels for the year, or on any other basis consistently applied across tax jurisdictions and from year to year. For this purpose, independent contractors participating in the ordinary operating activities of a Constituent Entity may be reported as employees. Tangible assets other than cash and cash equivalents The amount of tangible assets measured by the net book values of tangible assets of all Constituent Entities resident for tax purposes in the relevant jurisdiction. With regard to permanent establishments, assets should be reported by reference to the tax jurisdiction in which the permanent establishment is situated. Tangible assets do not include cash or cash equivalents, intangibles, or financial assets. Table II of the CbC template would require the Reporting MNE to annually provide the following information: 5

6 Constituent entities resident in the tax jurisdiction As noted above, a list, by legal entity name, of all the Constituent Entities which are resident for tax purposes in the relevant tax jurisdiction. Permanent establishments should be listed by reference to the tax jurisdiction in which it is situated and the legal entity of which it is a part should be noted. Tax jurisdiction of organization or incorporation if different from tax jurisdiction of residence The name of the tax jurisdiction under whose laws the Constituent Entity of the MNE is organized or incorporated if it is different from the tax jurisdiction of residence. Main business activity(ies) The nature of the main business activity(ies) of each Constituent Entity is reported by checking one or more of the following boxes: (i) Research and development; (ii) Holding or managing intellectual property; (iii) Purchasing or procurement; (iv) Manufacturing or production; (v) Sales, marketing or distribution; (vi) Administrative, management or support services; (vii) provision of services to unrelated parties; (viii) Internal group finance; (ix) Regulated financial services; (x) Insurance; (xi) Holding shares or other equity instruments; (xii) Dormant; and (xiii) Other. The list of activity categories is expanded from the list in the Discussion Draft. With respect to the Other category, an explanation should be provided in Table III (Additional information). Table III of the template provides room for the Reporting MNE to include any information or explanation that it considers necessary or that would facilitate the understanding of the required information provided in the template. Implications The new guidance provided in the Report with respect to the master file and local file differs from current documentation requirements. These differences will require companies to review their existing documentation and the process to produce it. The CbC template introduced in the guidance is an entirely new reporting requirement. Companies will have to take the necessary steps to ensure their ability to produce the required information, including preparing protocols for gathering the information and developing internal processes and responsibilities with regard to the new reporting. Moreover, there remain significant unanswered questions, most particularly the filing process for the master file and the CbC report and the mechanisms for which the information in these reports is to be made available to the tax administrations in all the relevant countries. More information in this regard is expected to be provided by the OECD in early Companies should monitor closely the development by the OECD of its recommendations on implementation approaches for these new reporting requirements. In addition, companies should monitor developments with respect to the adoption of such reporting requirements in the countries in which they operate. 6

7 For additional information with respect to this Alert, please contact the following: Ernst & Young LLP, International Tax Services, Washington, DC Barbara Angus Andreia Leite Verissimo Ernst & Young Belastingadviseurs LLP, Transfer Pricing, Rotterdam, The Netherlands Ronald van den Brekel Ernst & Young Advisory Services Ltd., Transfer Pricing, Johannesburg, South Africa Michel Verhoosel

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