Transfer Pricing Compliance Implications of the OECD’s BEPS Initiative
Author: Will James
A significant transfer pricing issue facing multinational enterprises (MNE) is Base Erosion and Profit Shifting (BEPS). This term refers to the negative effect of MNEs’ tax avoidance strategies on national tax bases. In some cases, BEPS can be achieved through inappropriate transfer pricing practices.
On October 5, 2015, the Organisation for Economic Co-operation and Development (OECD) released its final reports on the BEPS project. The final reports addressed 15 different action items put forth by the OECD in 2013, designed to curb base erosion and profit shifting by MNEs. The Group of 20 (G20), which endorsed the BEPS package at its October 8 meeting in Lima, Peru, commissioned the OECD to develop measures to combat perceived MNE abuses related to taxation of their cross-border activities.
The perception of the G20 finance ministers was that the existing international taxation and transfer pricing rules were inadequate and allowed MNEs to aggressively structure their cross-border arrangements to unfairly avoid or reduce their tax liabilities. As a result, the final reports covering the 15 action items released by the OECD substantially modified the existing international tax and transfer pricing rules. The next step is for the participating and nonparticipating countries to adopt the BEPS package as law. The changes within the BEPS package will profoundly affect all MNEs, requiring them to review their cross-border arrangements and increase their compliance efforts.
Action Item 13 addresses transfer pricing documentation. As of today, there is no standard format for transfer pricing documentation; countries have different stances as to whether documentation is required by law, forcing MNEs to handle multiple sets of varying requirements. Action Item 13 offers a standardized transfer pricing documentation format in the form of a master file and local country file. It also introduces the country-by-country (CbC) reporting template. The master file is a high-level document providing an overview of the MNE group’s business and industry, its legal entity structure, transfer pricing positions, financial information, discussion of its intangible property and functional and risk analysis. The master file is intended to offer tax authorities a comprehensive overview of the MNE group’s transfer pricing arrangements and supply chain in their entirety, rather than just the local country viewpoint that historically has been the focus of transfer pricing documentation prepared by MNEs. The local country file is a detailed file of the MNE’s local country positions related to transfer pricing and is essentially a local country transfer pricing study.
One of the more controversial items in the BEPS package is the reporting template, which requires MNEs to report revenues (split between related and third party), profit, taxes paid, stated capital, tangible assets and number of employees for each jurisdiction where they have legal entities or a permanent establishment. It also requires disclosure of each legal entity’s main business activity. Companies with consolidated revenues of €750 million or more must file the CbC reporting template in their home country 12 months after the accounting period commencing on or after January 1, 2016. The tax authority in the home country will share the CbC reporting template with treaty partners in the countries where the MNE does business. The template will offer tax authorities a high-level understanding as to whether the profit and tax paid is commensurate with activity in their country relative to other countries where the MNE operates. Some countries are expected to enact legislation that also would require MNEs with revenues under the €750 million threshold to file the CbC reporting template.
A number of countries, including Australia, Canada, Germany, the Netherlands, Poland, Spain, the United Kingdom and the U.S., already have passed legislation or stated their intention to pass legislation mandating filing of the CbC reporting template and preparation of the master and local country files. MNEs should review their transfer pricing arrangements and begin preparing to develop master and local country files.