A new world for multinationals
11 December 2014
Posted by: Author: Gerri Chanel
Author: Gerri Chanel (EY Tax Insights)
As increasing numbers of people call for better insights into who pays tax, and where, momentum is developing around a system for country-by-country reporting. This is the new reality that companies need to start planning for.
"It's no use going back to yesterday,” said Alice after arriving in Wonderland, "because I was a different person then.” And so it is for multinationals as they face a new tax reporting environment in which governments, activists and the broader public are seeking unprecedented detail about where companies earn revenues and the relationship of those activities to where taxes are paid.
On the pre-globalization, pre-internet side of the looking glass, a major share of companies’ profits was driven by physical assets and on-premises employees, making the geographical connections to profits relatively clear.
These days, as business has become increasingly global and the digital economy has undergone explosive growth, multinationals are tasked with assigning value to intangible assets such as intellectual property, and value chains are increasingly reliant on computing power and IT infrastructure.
The upshot is that the allocation of profits to the locations where business activity occurs is no longer as simple.
At the same time, cash-strapped governments are keen to scrutinize corporations' finances in a bid to uncover more tax revenue, and activists are speaking out against multinationals’ cross-border tax planning. "In the past,” says David Dietz, Head of Compliance — North America at Rabobank, "tax rate was an important component of how public companies managed their after-tax returns. Although rates can be managed in a way that complies with tax legislation, an approach that only focuses on whether planning is legal is just not acceptable anymore.” Politicians and the public are calling for multinationals to pay their "fair share” in the countries in which they do business and more than ever before, people want to know: who pays tax, and where?
Under the Action Plan on Base Erosion and Profit Shifting (BEPS) issued by the OECD, which was endorsed by the G20 governments in July 2013, one of the work streams has focused on developing a country-by-country reporting (CbCR) system as a means of answering that question. The OECD has also proposed more stringent transfer pricing documentation requirements for multinationals, in order to elicit a more thorough justification of prices and profit location within corporate groups.
"If country-by-country reporting and transfer pricing documentation requirements are implemented as currently indicated, then tax authorities will have unprecedented information about where the key activities in the value chain are that drive the profits and about where the profits get taxed,” says Ben Regan, a Transfer Pricing Partner of Ernst & Young LLP based in London.
Various CbCR initiatives have already been enacted, such as the Extractive Industries Transparencies
Initiative (EITI) that was launched in 2003, and others are on the horizon (see related story for more detail).
While it is not entirely clear how effective specific initiatives will be in achieving their goals and multiple
concerns exist about the use of the resultant data in unintended ways, CbCR is increasingly a reality that multinationals must start to plan for, according to those interviewed for this article.
While it is not entirely clear how effective specific initiatives will be in achieving their goals and multiple concerns exist about the use of the resultant data in unintended ways, CbCR is increasingly a reality that multinationals must start to plan for, according to those interviewed for this article.
OECD "BEPS Action 13” and more
The OECD formally unveiled its much-anticipated BEPS Action Plan at the July 2013 meeting of the G20 finance ministers. The Action Plan contains 15 actions, each linked to specific outputs to be delivered in 2014 or 2015. Action 13 of the Action Plan called for a review of existing transfer pricing documentation rules in order to provide tax authorities more focused and useful information for transfer pricing audits.
It also called for the development of a template for reporting income, taxes and economic activity on a per country basis. After a public consultation process, the final CbCR template and the transfer pricing documentation requirements were released in connection with the September 2014 G20 Finance Ministers meeting. The template requires reporting of aggregated information by country (not entity), financial data covering revenue, earnings before tax, cash tax, current tax, stated capital and accumulated earnings, employee head count, tangible assets, a list of all group entities by country, and business activity codes for each entity’s major activities.
While the OECD does not make tax law, the concept of high level CbCR has been endorsed by the G8 and the G20, and it is therefore expected that many countries will act on the OECD recommendations. "There are already signals that some governments are thinking of including the OECD work in their domestic law, such as the UK,” says Ronald van den Brekel, a partner in EY’s Transfer Pricing Group based in the Netherlands. "Some territories might implement legislation soon now that the template is finalized which could mean companies have to report from 2015.”
"It is very easy for a country to include the new guidelines in its domestic law — they can simply refer to
the template and ask companies to provide that information”, says Thomas Borstell, EY’s Global Director of Transfer Pricing. Borstell says some countries will adopt their own variations of the OECD recommendations while others may not adopt them at all. "There will be big differences from one country to another. But, we will definitely see some adoption because all the governments believe these measures will help them raise more revenue,” he says.
Concerns about CbCR
The OECD’s recommendations for CbCR and related transfer pricing documentation are intended to provide tax authorities with the information they need to make high-level assessments of whether profits are being taxed in the jurisdiction where they are earned in accordance with the functional profile of a company. However, in practice, problems can arise in the use of the information by tax authorities.
One problem is the potential for inadvertent misinterpretation, particularly if bulk data are provided without indexing, explanation or context. With such mass data, van den Brekel says tax authorities are likely to come up with incorrect indicators since, without an explanation from the company behind it, it’s very difficult to correctly interpret. "Mass unclustered data gives the impression of transparency and of something that tax authorities can use but, in the end, it most likely will not help them because it’s like trying to see the forest for the trees. Therefore it’s very important that the information is provided with sufficient explanation accompanying it,” says van den Brekel.
Another risk, adds Regan, is that even if only highlevel data are provided, authorities may be tempted to
raise assessments based on formulary apportionment — taxing the corporate group as a single entity — rather than using the arm’s length transfer pricing principle. "For example, tax authorities may look at the amount of profit declared per employee in their territory and propose an adjustment if it doesn’t stack up compared to company operations elsewhere,” explains Regan.
Yet another concern is that data intended only for tax authorities will become public or known to competitors, particularly since not all countries are as strict on tax secrecy as others. Competitors can use commercially sensitive information to their advantage.
Stories also abound about public misinterpretation of data. One example recounts a journalist accusing
a multinational of being located in tax havens, while the reality is simply that the company sells the same staple item in these places that it sells in dozens of other countries around the world. In this case, it is easy enough to rebut a false conclusion, but some complex yet equally valid tax situations are not as easy to explain in a public forum, particularly when only sound bites are expected.
Companies may face additional challenges as CbCR continues to take root. One is the disparity between various initiatives. "At the moment,” says Ross Lyons, the Global Head of Tax at Rio Tinto "the position is getting more complex from the viewpoint of providing different information by country and region, which may confuse readers.” Another problem, says Rogier Rolink, VP of Tax — EMEA and AP Regions at Royal Dutch Shell, is that "Some countries may have legitimate national security interests for limiting disclosure of information on revenues from their national resources. So, some countries prohibit us from disclosing certain information. Under the mandatory requirements for reporting in the EU, there is no exemption where such a conflict of law exists. Secondly, disclosure of the commercial terms of a project under a project level reporting regime may provide a competitive advantage where our competitors do not disclose such information. Shell finds it important that revenue transparency is done on the basis of a level playing field, being applicable to all extractives companies. Lastly, there are several transparency initiatives and it is important to us to minimize the reporting burden. Ideally, we would like to be able to produce one report that complies with each of the regulations that we are subject to. Therefore, we ask for equivalence to be granted in the mandatory rules to achieve this.”
Some countries may be quick to adopt the OECD recommendations and Borstell points out that if just one significant jurisdiction adopts them, a multinational operating there may need to make changes across the entire organization in order to be able to access the required information.
"Most companies are not able to produce such reports today,” says Borstell. "They will have to do
significant work to ensure compliance.”
In addition to looking at the OECD’s template to determine what information is required, van den Brekel
says companies should look at the data from the perspective of tax authorities. They should see if false
indicators come up that may arise from an incorrect interpretation of data (rather than the tax policy of the company), in order to prepare for likely questions from tax authorities. "It is also a great moment for companies to review their transfer pricing policies and identify any inconsistencies,” he says.
While the exact format of CbCR reporting is still in flux, "tax transparency will either come through mandatory requirements or it will be voluntary, but it’s coming,” says Ross Lyons of Rio Tinto. And from all indications, it is coming fast.
This article first appeared on taxinsights.ey.com.