Until recently, “transfer pricing” was a term used only by those involved in the complex world of international finance and corporate tax planning. Now, thanks to growing public anger about corporate tax avoidance, it has entered the public consciousness.
What is Transfer Pricing?
In a nutshell, transfer pricing rules determine the price that should be charged in transactions between two “related” companies, and typically between two members of the same corporate group. These rules oblige these entities to conduct transactions at “arm’s length,” as if they were unrelated, to prevent them from securing tax advantages that wouldn’t otherwise be possible.
The Call For More Transfer Pricing Transparency
The OECD recommended that countries upgrade their transfer pricing documentation frameworks in its final Action 13 report on base erosion and profit shifting (BEPS). To enhance transparency for tax authorities, the OECD proposed that multinationals (MNEs) should be obliged to provide all relevant governments with standardised information on the global allocation of their income, their economic activities, and the taxes they pay, among other things.
OECD Guidance On CbC Reporting
OECD guidance in this area describes a three-tier approach:
First, it recommends that MNEs should be required to provide tax administrations with high-level information regarding their global business operations and transfer pricing policies in a “master file,” which would be made available to all relevant tax administrations.
Second, it says MNEs should present detailed documentation in a “local file,” with information specific to each country in which they operate. This would identify material related-party transactions, the amounts involved in those transactions, and the company’s analysis of the transfer pricing determinations they have made with regard to those transactions.
Third, it says MNEs should be required to file a country-by-country (CbC) report. This would provide information relating to each tax jurisdiction in which they do business annually. This documentation should include data on revenue, profit before income tax, and income tax paid and accrued. MNEs would also be required to report on the size of their workforce, stated capital, retained earnings, and tangible assets in each jurisdiction. Last, it would require MNEs 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 engages in.
It is intended that CbC reports would generally be filed in the jurisdiction of the parent entity and then shared automatically through government-to-government information exchange frameworks.
How Have Nations Responded?
A number of countries have already legislated for, or are in the process of legislating for, the introduction of CbC reporting.
Legislation to provide for these reports has been passed in Australia, Denmark, Spain, the Netherlands, Ireland, and Mexico, for financial years beginning on or after January 1, 2016.
The UK held a consultation on draft regulations for the implementation of CbC reporting from October 5 to November 16, 2015, while the US Treasury Department released proposed regulations for CbC reporting on December 21, 2015.
Weighing Up The Changes
The introduction of new documentation rules has been described by tax practitioners as the single largest change in the area of transfer pricing since transfer pricing rules were first introduced some fifty years ago. But is this a change for the better?
Naturally, the OECD seems to think so; it says that tax authorities will be able to target their audit activities much more precisely, and therefore use their resources more efficiently. It also argues that MNEs themselves will benefit from more certainty and reduced compliance risks.
However, business and industry representatives have warned that CbC reporting will lead to the opposite: substantially increased administrative burdens and more speculative investigations by tax authorities. Concerns about privacy and data security have also been raised, including in the US Congress.
Either way, with several countries developing legislation in this area, CbC reporting is something that multinationals will have to become accustomed to.