OECD/G20 Base Erosion and Profit Shifting Project, Action 13: Guidance on Transfer Pricing Documentation and Country-by- Country Reporting Country-by-country report Outliers Analysis in practice 5 July 2016 [To be specified by MNE]
Page 2 of 6 Country-by-Country (CbC) report outliers analysis 1 In order to capture any major inconsistencies of CbC relevant data points and/or potential TP risk areas, it is crucial to conduct relevant outlier analysis of the data points generated in the draft CbC report. The review and analysis of the draft CbC report would help to identify areas which potentially may be challenged by tax authorities. The outliers analysis covers a financial ratio analysis by undertaking various what-if financial simulations under key tax/ TP scenarios with respect to the major type of IC transactions. The various what-if financial simulations under each scenario would allow to identify potential tax/tp risks within the tax/tp system. In order to apply the analysis efficiently, it is essential to define which ratios are normal for the group and/or for the industry, as well as, what is considered as an outlier and what could be treated as an acceptable standard deviation. Moreover, it is necessary to choose an applicable statistical methodology, e.g. an interquartile range. The outlier analysis includes the following financial ratios and questions that tax inspectors may raise while screening CbC reporting: 1. Profit before taxes ( PBT )/Total revenue This ratio presents entity s earnings before tax as a percentage of total revenues. This ratio shows profitability of entity: the higher the pre-tax profit margin, the more profitable the entity. The profitability of the entity should match its responsibility profile, e.g. when MNEs incurs overall losses, they should first have impact on the profitability of profit centers not cost or revenue centers. Why entity A is so unprofitable (-800%)? Is it a continuous loss? What are the reasons of loss? Why entity B (795%) is extremely profitable comparing to the other group entities? Does it receive a residual profit related to group intangibles? Why the most profitable entities are in Singapore and Dubai (in other preferable tax jurisdictions)? Is this in line with their responsibility profiles (e.g., they are profit centers)? Why in entity C related party revenues are much higher than unrelated party revenues? Is this in line with its responsibility profile (e.g., it is a cost centre)? 1 The first layer of analysis; the second layer includes split of country data per legal entity and per individual transaction.
Page 3 of 6 2. Income tax accrued-current year/pbt This ratio shows the current tax expense which reflects only operations in the current year and does not include deferred taxes or provisions for uncertain tax liabilities. De facto this ratio represents approximation of effective tax rate ( ETR ) which, if lower than 10%, will certainly be questioned by tax authorities. Why US/UK entity has a relatively low ETR ratio? Why entity A has the highest ETR ratio? Is there any indebtedness? Why entity B has a positive ETR ratio ( negative tax position )? Are there any amounts of tax to be paid back? 3. PBT/Tangible assets This ratio gives an indication how profitable an entity is relative to its tangible assets i.e. it is a part of return on assets ratio ( ROA ). This ratio also reflects how efficient management is at using its assets to generate earnings. Why entity D has a high percentage of assets comparing to the other group entities while having losses? Why entity E has an extremely high PBT/tangible assets percentage comparing to the other group entities? Is this in line with its responsibility profile (e.g., it is a profit centre)? 4. Tangible assets/total revenue This ratio shows entity s tangible property that is capable of producing economic value. It works as a filter for economic activity of the entity showing, for example, if an entity is a broker with low amount of assets or a distributor with a high one. The filtering can be further cross-checked through the table 2 of CbC report showing entities business activities. Why entity A is more asset intensive than entities B and C while they are all manufacturing entities? Why entity D has a high level of tangible assets being a sales entity? Does it match its risk profile of a full risk distributor?
Page 4 of 6 5. Total revenue per FTE This ratio shows how much revenue each employee generates. It particularly highlights mismatches between generated value and allocation of people functions. This ratio also provides information on entity's efficiency within the group and intensity of functions within the entity. Depending on the activity of the entity, it may show, for example, sales intensity of sales & marketing hub. Why there is revenue in entities where there is one or no employees? For example, Bermuda with no employees The highest ratio is in Singapore where there is only 1 employee and in Hong-Kong where there are only 3 employees on the payroll. Are the profiles of Japan and Hong- Kong providing high-value adding services to justify such high level revenue per employee? Why is there relatively small revenue per FTE in India where there are 5000 employees? 6. Number of FTEs vs. PBT Together with the previous ratio this comparison helps to analyze economic substance of each entity within the group. Particularly, entities with zero FTEs and positive PBT as tax authorities would immediately question the economic substance of profits. In addition, the analysis of substance may be performed with a cross-reference to the table 2 listing business activities. In particular, the following activities require more than 5 FTEs per constituent entity: Research and Development, Holding or Managing intellectual property, Purchasing or Procurement, Manufacturing or Production, Regulated Financial Services. If there are less than 5 FTEs, it is necessary to check the economic substance reflected by the presence of people functions. 7. Stated capital + Accumulated earnings vs. tangible assets This comparison reflects the leverage of the entity. Particularly, if stated capital plus accumulated earnings are significantly lower than fixed assets, there is a high likelihood that the entity is highly leveraged. This may trigger further discussion with tax authorities regarding deductibility of interest and compliance with thin capitalization rules. 8. Income tax paid (on cash basis) vs. PBT This comparison may highlight the entities with potential net operating losses ( NOL ) meaning that the entity was allowed to have tax deductions greater than its taxable income
Page 5 of 6 for previous years, resulting in a negative taxable income. This tax relief, however, may be closely monitored for reasons of negative taxable income. This comparison also filters out companies that have a tax holiday or a preferential tax regime or a residence in 0% corporate tax jurisdictions as follows: if tax paid is zero, while PBT is more than zero. Identification of such entities within the group may trigger further discussion with tax authorities regarding potential shifting of profits. 9. Potential base erosion and profit shifting ( BEPS ) indicators There are several parameters to test an MNE with regards to OECD BEPS Action plan highlights, such as hybrid mismatches and significant shifting of profits. Profit before tax per FTE > EUR 1 millions and/or Accumulated Earnings per FTE > EUR 5 millions could show that significant amount profits were shifted to jurisdictions with low or no taxation. Dual residence, i.e. location of incorporation vs. locations of tax jurisdiction, may give an indication of hybrid entity depending on the countries in question. Conclusion Based on the review and analysis mentioned above, the selected risk profile by MNE could be defined and captured in the following table:
Page 6 of 6 1 st layer analysis # Financial performance Economic indicator/result 1 Profit before tax ( PBT )/ Total revenue Earnings before tax ( EBT ) 2 Income tax accrued current year/pbt Effective tax rate ( ETR ) 3 PBT/Tangible assets Return on Assets ( RoA ) 4 Tangible assets/total Filter for economic activity (e.g., revenue distributor) 5 Total revenue per FTE Intensity of functions 6 Number of FTES vs. PBT Analyze economic substance Stated capital + 7 Accumulated earnings Leverage intensity vs. tangible assets Potential net operating losses 8 Income tax paid (on ( NOL ); Tax holding, preferential cash basis) vs. PBT tax regime or 0% corporate tax jurisdiction Dual residence: location of incorporation vs. locations of tax Potential BEPS indicator jurisdiction 9 Profit before tax per FTE Potential BEPS indicator > EUR1 million Accumulated Earnings per FTE > EUR 5 millions Potential BEPS indicator MNE specific standard +/- deviation Industry specific standards Outliers MNE specific comments on economic/legal/accounting consequences of outliers