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Country-by-country reporting: Raising the bar for transfer pricing risk management

Tuesday, 14 October 2014   (0 Comments)
Posted by: Author: BDO South Africa
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Author: BDO South Africa

Country-by-country reporting will greatly increase the transparency of businesses’ value chains, the robustness of associated transfer pricing policies and how well these are implemented. This greater visibility and attention will increase transfer pricing risk. Businesses should prepare now by testing the efficacy of their transfer pricing policies and data gathering processes. 

The OECD’s adoption of country-by-country reporting (CbCR) is part of a new, three-tier, transfer pricing documentation requirement for multinational enterprises (MNEs) alongside a master file and local file. 

The CbCR obligation is set out in Chapter V of the OECD’s new Guidelines on transfer pricing. It was issued as part of the ongoing review of base erosion and profit shifting (BEPS) in international tax.

CbCR is intended as a tool for tax authorities to risk assess MNEs’ transfer pricing. This will greatly increase transparency for local tax authorities through the reporting of key financial metrics across a group. Its adoption is part of the OECD’s desire for a wider ‘culture of compliance’ that can also be seen in the wider changes to the transfer pricing documentation requirements in the new Chapter V.  The effect of this new visibility will be:

  • Increased transfer pricing risk from the availability of annual headline data across a group to each tax authority
  • The need to ensure that transfer pricing policies are appropriately tailored for the facts, circumstances and requirements of each territory – one size is now even less likely to fit all
  • To further raise the profile of transfer pricing and its tax effects among MNEs’ stakeholders.

Clearly, businesses will need to ensure that their transfer pricing policies are both current and effective, and that the relevant financial metrics can be provided efficiently and with confidence.

What are the reporting requirements?

CbCR requires the following information to be provided annually in a standard template for each territory where the group has a taxable presence:

  • Revenues, split between related and unrelated parties
  • Earnings before income tax (but after expenses and exceptional items)
  • Income taxes paid on both a cash and accrued basis (to local and other countries), including withholding tax
  • Stated capital and accumulated earnings
  • Number of local employees
  • Tangible assets (but not cash or equivalents).

The OECD acknowledges that some emerging market territories may wish to add detail to this list, including transaction information around royalties, interest payments and service fees.

All taxable entities in each territory must be listed on a second schedule together with their tax jurisdiction if this is different from their jurisdiction of tax residence. The main activity of each entity must be flagged on a check-box list.

Finally, the OECD template provides a blank page for further information that a business considers necessary or which would enhance understanding of the forms. 

Who will CbCR affect?

CbCR must contain data for all of the MNE’s entities regardless of their size, in each jurisdiction. There is no CbCR exemption for small and medium sized entities and the OECD is clear that this information should be provided if requested by tax authorities. Therefore, the adoption of CbCR could affect all MNEs.

The formal requirement to prepare CbCR will follow obligations for transfer pricing documentation as the OECD includes CbCR in the three-tier documentation package.

Local exemptions from transfer pricing documentation could remove local CbCR filing requirements but MNEs headquartered in such territories should review the requirements for their overseas subsidiaries and be prepared to provide this information to meet CbCR obligations in other jurisdictions. 

When will CbCR start?

A formal start date is yet to be announced. The OECD is considering this and is expected to report back early in 2015 – including on ways to phase in the requirement. Full implementation may depend on formal local adoption, although the global nature of CbCR information means that having just one compliant territory in a group will require preparation of the form. The UK is to be an early adopter but no start date has been announced.

Best practice filing arrangements will also be announced in early 2015. Sensitivity to the disclosure of data within a business is acknowledged. The OECD is considering options such as the central filing of CbCR and tax authority access through treaty exchange of information powers. However, direct local filing on tax authority request is likely to be the norm in practice.

Some evolution of the template should also be expected. The OECD has promised to revisit CbCR standards before the end of 2020 with a view to continuously improving their operation.

Meeting the challenge of CbCR

CbCR asks three key questions of multinationals:

1.   Are transfer pricing policies current and robust?

CbCR provides tax authorities with a much greater level of visibility. MNEs will need to have comfort that their transfer pricing policies remain current – in line with the business model and substance – and have not fallen behind commercial activity.

2. Does our implementation of the transfer pricing policy give us expected results?

CbCR is focused wholly on results. These results should be tested against transfer pricing policy and supporting comparables to ensure implementation is robust. The level of extra detail for the CbCR template’s ‘blank page’ should also be addressed to ensure that disclosure is appropriate.4

3. Do we have the processes to efficiently extract and confirm the required information?

Meeting the requirements of CbCR also requires efficient processes to extract and provide the appropriate information with confidence. Testing the business’s ability to achieve this and identifying systems or reporting issues early will be critical.

Best practice

Tax authorities will use CbCR data to risk review local operations of an MNE. A key part of a business’s 
preparation for the introduction CbCR should be to anticipate these reviews and take any remedial action 
necessary so that it can have confidence in its filings.

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