OECD White Paper on Transfer Pricing Documentation proposes coordinated approach based on a two-tier structure

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1 OECD White Paper on Transfer Pricing Documentation proposes coordinated approach based on a two-tier structure July 31, 2013 In brief On July , the OECD published its White Paper on Transfer Pricing Documentation (White Paper) as part of the ongoing workstream on transfer pricing simplification and following the inclusion of the matter in its Action Plan on Base Erosion and Profit Shifting ( BEPS Action 13, released on July 19, 2013). Rapidly spreading local transfer pricing documentation requirements and the complexity of the rules have put the topic on the agenda of policy-makers. The OECD sees potential for standardisation to reduce compliance costs for taxpayers, but equally puts emphasis on the role that transfer pricing documentation can play for enhanced transparency and improved risk assessment. In this sense, the White Paper takes stock of existing approaches to harmonise transfer pricing documentation, but goes considerably further by proposing a Coordinated Approach to Documentation based on a two-tier structure. The OECD is inviting public comments on the White Paper to obtain input from the business community and other interested non-governmental parties by October 1, In detail Mapping existing guidance and complexities The 42 page extensive White Paper observes that transfer pricing documentation rules are and will continue to be elements of local law. Local documentation regimes are increasing and vary significantly; but common features observed by the OECD include the one-sided approach to analysing controlled transactions and the fact that the transfer pricing documentation prepared does not always allow for a complete understanding of the overall business. Despite (or due to) these existing differences in local transfer pricing documentation regimes, the OECD sees room for better international coordination on the content and the format of transfer pricing documentation. The current guidance as surveyed by the OECD can largely be split into local country documentation regimes and international initiatives to streamline documentation requirements. The latter include most notably the existing Chapter V of the OECD Transfer Pricing Guidelines (dating back to 1995) and the Code of

2 Conduct on Transfer Pricing Documentation for Associated Enterprises in the European Union ( EU TPD ). The White Paper also refers to the PATA 1 documentation package and the proposals of the International Chamber of Commerce. In practice, the two-tier approach of the EU TPD, consisting of one masterfile supported by countryspecific documentation, appears to be the most advanced guidance up to date, but the OECD observes that there are some flaws to it and that the level of formal adoption is low, although in practice many multinational groups follow a broadly similar documentation strategy. Upon preparation of the White Paper, the OECD also consulted selected business representatives through conversations with BIAC members. The observations of the business representatives confirm the burdensome character of transfer pricing documentation, which has been described as detailed and massive. OECD identifies three purposes for transfer pricing documentation To advance with the work on simplified and improved transfer pricing documentation, the White Paper suggests three purposes of transfer pricing documentation requirements as a starting point. Consensus on the purpose of documentation requirements is regarded to be a key element for direction on the possible format and 1 Pacific Association of Tax Administrators. content of harmonised transfer pricing documentation guidance. The three (non-exhaustive) purposes of transfer pricing documentation comprise: 1. Risk assessment: Transfer pricing documentation provides tax administrations with the required information for risk assessment at the beginning of tax audits. 2. Taxpayer consideration of transfer pricing: Documentation requirements are regarded as means to ensure that taxpayers sufficiently consider their pricing and conditions of intra-group transactions. 3. Information during a tax audit: Transfer pricing documentation should provide tax auditors with the necessary information to conduct an audit of transfer pricing practices affecting their jurisdictions. The White Paper highlights that there are differences as to how countries collect information on the transfer pricing practices of taxpayers. Examples for local approaches are e.g. transfer pricing forms which need to be filed together with the annual tax return, transfer pricing questionnaires or cooperative approaches promoted by some jurisdictions such as the Netherlands and the UK. OECD suggests a tiered approach to transfer pricing documentation of a big picture nature Section IV of the White Paper provides an outline of the possible structure and content of harmonised documentation rules. The elements included in the documentation package suggested consist of typical information which is to a large extent already required under many local transfer pricing documentation rules. However, in addition, the OECD puts forward a number of elements which may be less typical for local documentation packages, and which intend to draw a clear big picture overview on a taxpayer s transfer pricing policies. In order to determine which information should form part of transfer pricing documentation, the OECD strongly leveraged on previous work identifying main risk indicators in transfer pricing. These include, for instance, the nine features contained in the 2012 OECD report Dealing Effectively with the Challenges of Transfer Pricing. Predominant examples are transactions with low tax jurisdictions, transactions involving intangibles, business restructurings and intra-group transactions involving interest and royalty payments. The White Paper lists information which would put tax administrations in a position to identify such risk factors. This also includes existing APA and ruling arrangements related to income allocation in different jurisdictions. Nevertheless, the taxpayer s description of the transfer pricing methods and analysis continues to be the heart of transfer pricing documentation. The White Paper builds on the twotier structure proposed under the EU TPD; with a global masterfile including components such as a description of the overall business and the functional analysis, information regarding business restructurings and transfers of intangibles. Furthermore, information regarding consolidated group income, tax rates and the debt structure should support the elements included in the masterfile. Local country and transaction specific information would be included in the local country documentation, which 2 pwc

3 Tax Controversy and Dispute Resolution Alert would include for instance a detailed functional analysis of the local taxpayer, the application of the transfer pricing methodology and the economic analysis. Additionally, the White Paper notes that it is likely that business could provide, without undue burden, individual country data demonstrating how global income is allocated, and how that allocation compares to the location of employees, assets, or sales. That is consistent with the recommendation in the BEPS Action Plan to develop country-by-country reporting requirements for income, economic activity and taxes paid. The table below lists the key elements of the OECD s proposed Coordinated Approach to Documentation 2 : Masterfile Local File Overview of the Multinational Enterprise Group Charts on legal and ownership structure, geographical location Management structure and geographical location of key management personnel Description of the business Written description on e.g. important profit drivers, the supply chain, important related party service arrangements, functional analysis on principal contributions to value creation and a description of business restructurings occurred during the last 5 years Internet links to representative industry analyses Intangibles of the Group, including e.g. description of the overall strategy on development, ownership and exploitation of intangibles list of material intangibles and overview on entities entitled to returns derived list of important related party agreements related to intangibles description of related transfer pricing policies description of material transfers of interest in intangibles during the relevant year Financial activities material intercompany loans and other financial arrangements and an overview on the parties in involved, their location and the principal amounts intercompany transfer pricing policy Financial and tax positions Description management structure of the local entity, reporting lines and location of senior executives Indication whether the local entity has been affected by business restructurings/transfers of intangibles during present/past year Controlled Transactions, including: Description of controlled transactions Aggregate amounts of intercompany charges per transaction Identification of associated parties for each category of controlled transactions Detailed functional analysis of taxpayer with respect to each category of controlled transactions Other controlled transactions that directly/indirectly affect the taxpayer Indication of most appropriate transfer pricing method per category of transaction and reasons for selecting the method Selection of the tested party Important assumptions made for the transfer pricing analysis Reasons for performing a multi-year analysis (if relevant) Selected comparable uncontrolled transactions Comparability adjustments performed Reasons for conclusion that controlled transactions were conducted at arm s length Summary of financial information used in applying the transfer pricing methodology Financial information consolidated accounts list and brief description of the Group s applicable APAs and other relevant tax rulings Pending MAP and MAPs resolved during the last 2 years Schedule on number of employees per country Consolidated income statement Annual local entity financial accounts (current/previous years) Allocation schedules tying financial data used for application of transfer pricing method to annual financial statements Summary schedules on relevant financial data for comparables used 2 Based on Section V of the White Paper on Transfer Pricing Documentation. 3 pwc

4 The OECD also proposes consideration of the mechanics related to the preparation of transfer pricing documentation, such as the use of local or regional comparables, materiality thresholds and translation requirements. The takeaway PwC assessment: OECD pushes for high degree of transparency via two-tier documentation package The OECD s White Paper on Transfer Pricing Documentation fits in neatly with its other ongoing areas of work, including the BEPS Action Plan, the Revised Discussion Draft on Intangibles (also launched on July ) and the Handbook on Risk Assessment in Transfer Pricing. It is apparent that even though the White Paper was released as part of the work stream on simplification measures, there is a clear link to promoting wider disclosure of what are called high-risk transactions and aggressive/tax avoidance schemes. The explicit reference to unilateral APAs or other relevant rulings which would be disclosed under the Masterfile is also worth noting. It is here that the White Paper is not only to be seen as going deeper in Action 13 of the Comprehensive Action Plan (CAP) as released on July 19, but also touches on Actions 5, 10 and 12. Indeed, at first glance, the OECD s vision on transfer pricing documentation appears to match existing documentation approaches of MNEs in leveraging on the existing two-tier structure proposed by the EU TPD. However, the White Paper is ultimately another step in urging taxpayers to provide more qualitative information on their intercompany pricing. The role of a thorough functional analysis as a building block to robust documentation is again stressed. This lies at the heart of what the BEPS CAP aims to achieve and also fits in the EU Joint TP Forum s proceedings on risk assessment. At the end of the day, robust TP documentation should enable tax inspectors to identify where true tax risk lies without having taxpayers to spend a disproportionate amount of effort to compile a compliance file. However, the pendulum is shifting in a sense that understanding the big picture will now be allotted a preponderance over the mere mechanical focus on pricing matters on a transactional basis. This is also where the relevance of this White Paper comes in when assessing the Revised Intangibles Discussion Draft that was also released on July 30, The (functional) corporate value chain is seen as the starting point for any thorough transfer pricing (intangibles) analysis. The White Paper calls without undue burden for business - for individual country data based on either management accounts, consolidated income statements and balance sheets, and/or tax returns that would provide tax administrators with a general sense as to how their global income is allocated and where pressure points in the transfer pricing arrangements might lie. Even though this would not provide a substitute for a full functional analysis or a sufficient basis for a detailed transfer pricing analysis of individual transactions and prices the White Paper says, these recommendations are noteworthy in understanding how the role of transfer pricing compliance is elevating. The BEPS CAP says in Action 13 that rules will be developed to include a requirement that MNEs provide all relevant governments with needed information on their global allocation of the income, economic activity and taxes paid among countries, according to a common template. Although the White Paper notes that this kind of information should only be used for risk assessment purposes, and not, by itself, for making transfer pricing adjustments, it could potentially result in more pressure to align profits and taxes paid with the location of employees, assets, or sales. Our network of PwC experts will review the White Paper in more depth and prepare a comment for submission to the OECD. If there are any items that you would like to discuss in more detail, feel free to reach out to any of the contacts listed below or to your local PwC advisor. 4 pwc

5 Let s talk For a deeper discussion of how this issue might affect your business, please contact: Transfer Pricing Isabel Verlinden, Brussels isabel.verlinden@pwc.be Adam Katz, New York adam.katz@us.pwc.com David Ernick, Washington D.C david.ernick@us.pwc.com Madlen Haupt, Brussels madlen.haupt@pwc.be Jonas Van de Gucht, Brussels jonas.van.de.gucht@pwc.be Richard Collier, London richard.collier@uk.pwc.com Send feedback 2013 PricewaterhouseCoopers LLP. All rights reserved. In this document, PwC refers to PricewaterhouseCoopers (a Delaware limited liability partnership), which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity. 5 pwc