The Group of Twenty (G20) and Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) project will see a paradigm shift in the international tax and transfer pricing landscape.
Having completed Phase 1 of its BEPS project, the OECD has released seven deliverables, two of which are expected to shape much of the future direction in transfer pricing, disputes and controversy arising under the BEPS recommendations. These two deliverables are:
- Changes to the transfer pricing rules in relation to documentation requirements (Action 13) reflected in the OECD’s Guidance on Transfer Pricing Documentation and Country-by-Country Reporting.
- Changes to the transfer pricing rules in relation to intangibles (Action 8), reflected in the OECD’sGuidance on Transfer Pricing of Intangibles.
Changes to the transfer pricing rules in relation to documentation requirements (Action 13 reflected in the OECD’s Guidance on Transfer Pricing Documentation and Country-by- Country Reporting
The new documentation and country-by-country (CbC) reporting requirements arising from Action 13 of the BEPS Action Plan are expected to result in unprecedented levels of global transparency over multi- national corporations’ (MNCs’) value chains, economic footprints, profit allocations and transfer pricing arrangements.
The transfer pricing documentation deliverable introduces a ‘three-tiered’ approach to transfer pricing documentation, recommending that the documentation package includes:
- A ‘master file’ containing standardised information relevant for all MNC group members.
The information required to be captured in the master file is grouped in five categories:
- The MNC group’s organisational structure
- A description of the MNC’s businesses
- The MNC’s intangibles
- The MNC’s inter-company financial activities
- The MNC’s financial and tax positions
- A ‘local file’ referring specifically to material transactions of the local taxpayer and containing the required transfer pricing analysis to validate the arm’s length nature of those transactions.
- A CbC to be prepared by the ultimate parent entity of the MNC group, aggregating tax jurisdiction- wide information relating to the global allocation of income, taxes and certain indicators of economic activity among tax jurisdictions in which the MNC group operates.
The above recommendations are expected to be taken into account by tax administrations in developing rules and/or procedures on transfer pricing documentation, as well as by MNCs in preparing transfer pricing documentation to demonstrate that their transactions satisfy the arm’s length principle.
The CbC reporting requirements reflect perhaps the most controversial aspect of the transfer pricing documentation deliverable as it requires MNCs to report an array of information considered quite easily susceptible to misinterpretation, which is likely to have unwarranted consequences for MNCs.
Appendix 1 to this article provides an overview of the evolution of the CbC reporting template, from the original template proposed in the revised discussion draft issued on 30 January 2014 to the revised template reflected in the issued deliverable.
Implication for future directions in transfer pricing
The ramifications of the documentation and reporting requirements will drive the future directions in transfer pricing which are likely to lead to:
- increased compliance costs for MNCs and the need for integrated transfer pricing systems and processes
- the need to carefully consider both criminal and administrative sanctions in the context of CbC reporting and transfer pricing documentation requirements, and
- increased revenue authority activity, including audits, adjustments and disputes as well as the potential for double taxation.
The extent of increased revenue authority activity will largely depend on the implementation process adopted in respect of the recommended three-tiered reporting package and how that information will be made available to tax administrations in all relevant countries. Recommendations on these matters were not provided by the OECD in its deliverable and are instead expected in 2015, with full implementation of the three-tiered reporting package expected by 2016/17.
In response to the OECD’s deliverable, MNCs should assess the status of their group’s transfer pricing documentation. The question that should be asked is – when did the MNC last undertake a concerted effort to update and strengthen its transfer pricing documentation? For most MNCs, there is no better time than now to carry out a thorough stocktake of their transfer pricing documentation and prepare for implementation of the OECD’s recommendations.
Changes to the transfer pricing rules in relation to intangibles (Action 8), reflected in the OECD’s ‘Guidance on Transfer Pricing of Intangibles’
The reason intangibles are such an important concept in transfer pricing is that often, a substantial proportion of the MNC’s economic value (i.e. profit) is attributable to the MNC’s intangibles, rather than their manufacturing, supply or distribution functions. The relevance of this in a transfer pricing context becomes particularly clear when considered in light of the generally ‘mobile’ nature of many intangibles (or ownership thereof) which facilitates ownership of the intangibles by entities located in ‘lower tax’ jurisdictions, with the arm’s length principle being relied upon to attribute a large portion of global profits to those entities. Unsurprisingly therefore, there is a focus of the OECD’s BEPS Action Plan on intangibles.
The OECD’s Guidance on Transfer Pricing of Intangibles will establish the core guidelines for the arm’s length allocation of intangible related profits and accordingly form the core document many MNCs in OECD and G20 countries will rely on in validating the arm’s length nature of their intangible related cross border transactions.
The future directions in transfer pricing arising as a result of the OECD’s deliverable on intangibles are expected to include the following:
- A greater focus on substance and ‘important functions’ - Legal ownership of intangibles will not in itself confer rights to ultimately share in any significant return from exploitation of the intangibles following the implementation of the OECD’s recommendations. Placing a greater degree of importance on the ‘substance’ behind ownership of intangibles, the OECD’s Guidance on Transfer Pricing of Intangibles instead outlines that the legal owner of an intangible will be entitled to returns attributable to the intangible only if they perform the ‘important functions’, contribute the relevant assets and bear the risks associated with the development, enhancement, maintenance, protection and exploitation of the intangible.
- Increased certainty around some historically contentious areas – Improved guidance and clarity around factors such as location savings, certain market characteristics and group synergies. Specifically, the OECD’s Guidance outlines that these factors should not be considered as intangibles necessitating a separate return, but rather, matters to be addressed in identifying appropriate ‘comparables’ in transfer pricing analyses.
An Australian perspective
Australia has already unilaterally legislated rules to address its BEPS challenges and currently possesses an amassed arsenal of anti-BEPS measures, including, controlled foreign company rules, amended general anti-avoidance rules and modernised transfer pricing rules with powerful reconstruction provisions.
Australia’s ‘go-forward’ position on transfer pricing following the BEPS recommendations will see the Government taking action on three fronts:
- Implementing effective domestic policy changes - The OECD’s work will set out proposed recommendations and reforms for the Australian Government to consider and it will ultimately be up to the Government to decide what legislative and/or regulatory changes it will implement. Given Australia’s prominent role in driving the G20’s BEPS agenda, reinforced through its current ‘chairing’of the G20, it is expected that the Australian Government will implement most, if not all, of the transfer pricing related BEPS recommendations.
- Collaborating with the Commissioner of Taxation to strengthen administration - Treasury has requested that the Australian Taxation Office (ATO) doubles its efforts in investigating the tax practices of MNCs operating in Australia. MNCs operating in Australia can therefore expect increased scrutiny of their transfer pricing and tax practices over the short to medium term future, likely leading to further investigations from, and disputes with, the ATO.
- Pursuing multilateral international change - Australia is placing greater emphasis on cooperation with tax authorities worldwide to ensure greater understanding of international tax planning arrangements, fostering the sharing of such information, ultimately leading to concerted global efforts on addressing identified BEPS issues and taking action against perceived ‘tax abusers’.
G20 countries, and indeed other interested stakeholders, are seeing a paradigm shift in the international tax and transfer pricing landscape and there is little doubt that MNCs are entering increasingly turbulent times from a transfer pricing and international tax perspective. Accordingly, the time is right for MNCs to carefully assess their transfer pricing position with a view to validating the arm’s length nature of their intra-group transactions and establishing a strategic, proactive and comprehensive approach to transfer pricing policy, compliance and reporting management in order to mitigate the risks of transfer pricing uncertainty, prolonged disputation and increased incidence of double taxation.
CbC reporting template – Evolution
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