THE CHANGING ENVIRONMENT FOR TRANSFER PRICING DOCUMENTATION. Action 13 documentation and reporting requirements

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1 FEBRUARY 2015 THE CHANGING ENVIRONMENT FOR TRANSFER PRICING DOCUMENTATION A summary of the OECD recommendations including the latest on Country-by-Country Reporting On February 6, 2015 the Organisation for Economic Cooperation and Development (OECD) released its guidance relating to the form and content of the updated guidelines on transfer pricing documentation and Country-by- Country Reporting. The latest release ( Action 13: Guidance on the Implementation of Transfer Pricing Documentation and Countryby-Country Reporting ) adds details regarding implementation of Country-by-Country Reporting (CBCR). This bulletin provides an overview of the guidance on the form and content of the deliverables from the Base Erosion and Profit Shifting (BEPS) Action 13 relating to both transfer pricing documentation and CBCR. Action 13 documentation and reporting requirements The OECD documentation and reporting requirements are intended to: Help foster a culture of compliance within organizations Provide tax authorities with useful information so they can assess transfer pricing risks Provide information to help tax authorities determine the most effective way to deploy audit resources. The three tiers of documentation required are: Master File Local File(s) Country-by-Country Report Required for MNEs with total revenue 750 million The Master File provides a high-level overview of the Multi National Enterprise (MNE) group s global business operations and transfer pricing policies. This file is meant to ensure that tax authorities have an appropriate overview of the MNE s global business. Subject to local country rules governing implementation, the Parent Company should prepare and maintain a Master File in accordance with the due date established in the local country legislation or regulations. Local Files provide individual jurisdictions with detailed information on specific group transactions that are considered material under the local country s tax system. The local files are meant to show the taxpayer has complied with the arm s length principle. Subject to local country rules governing implementation, the Local Company should prepare and maintain a Local File in accordance with the due date established in the local country legislation or regulations. The CBCR will provide aggregate jurisdiction-wide information on the global allocation of the MNE s income, taxes paid, stated capital, accumulated earnings, number of employees, and other information showing the location of the economic activity within the MNE. The information has to be provided for each jurisdiction. As well, the CBCR must include all tax jurisdictions where the MNE has an entity resident for tax purposes, regardless of the size of the business operations in a country. Parent entities of MNE groups will file the CBCR in their jurisdiction of tax residence. The requirement for a Master File and Local File(s) is now in place and, in many cases, will mean that MNEs will have to update their existing documentation. See below for the timing of the implementation of CBCR.

2 OECD S implementation recommendations for the CBCR Here are the highlights of the OECD s recommendations regarding implementation of the CBCR: TIMING The OECD recommends that the first CBCR be required for MNE fiscal years beginning on or after 1 January 2016 with the due date for filing being one year from the close of the fiscal year to which the CBCR relates. The CBCRs will therefore likely need to be filed by 31 December EXEMPTION FOR SMALL SMEs Groups with total revenue of less than 750 million will be exempt. We anticipate that some countries might implement lower thresholds. Furthermore, we believe the thresholds will decrease in the future, once the authorities gain experience with this new tool. Regardless of the exemption, given that jurisdictions are directed to use the information contained within the CBCR to assess high-level risk in the context of larger groups, we believe it is useful for internal risk management purposes to prepare an internal CBCR to identify and minimize potential issues for smaller groups. FILING CBCRs will be filed annually, directly with the jurisdiction of the MNE s ultimate parent entity. They must be filed within one year of the close of the fiscal year. If the ultimate parent s home jurisdiction does not require a CBCR or there is no adequate mechanism for timely exchange of CBCRs (or a failure to do so in practice), the parent may have to file the CBCR with a tax authority a subsidiary reports to. USE OF THE CBCR TEMPLATE To ensure consistency, the OECD is emphasising that jurisdictions should accept filings that use the OECD-created CBCR template included in the September 2014 guidance. APPROPRIATE USE OF THE CBCR Jurisdictions are directed to use the CBCR to assess high-level transfer pricing risk and for assessing other BEPS-related risks. Jurisdictions should not use the information from the CBCR relating to income allocation to propose an adjustment of any taxpayer s income. Jurisdictions, however, may use the CBCR data as a basis for further enquiries into the MNE s transfer pricing arrangements or other tax matters in the course of a tax audit. CONFIDENTIALITY Information provided in the CBCR can only be exchanged between tax authorities through existing mechanisms under double tax conventions or other agreements - for example, Tax Information Exchange Agreements (potentially as modified by the multinational instrument which is included in Action 15 of the BEPS initiative). As well, the information will not be available to the public. GOVERNMENT-TO-GOVERNMENT EXCHANGE OF CBCRs a mechanism will be developed under which jurisdictions that receive a CBCR report by a parent entity can automatically exchange the information with jurisdictions in which the MNE group operates. 1

3 Take action now The OECD requirement for a Master File and Local files is now in place and will, in many cases, mean that MNEs may have to update their existing documentation. Given that the OECD expects the first CBCRs will be filed for fiscal years beginning on or after 1 January 2016, enterprises should also begin taking steps now to ensure they will be ready to meet the new requirements. We recommend enterprises prepare a preliminary CBCR to test their transfer pricing policies and reporting mechanisms given that one of the goals of the CBCR is to ensure enterprises have a robust transfer pricing policy. The exercise will provide critical information the MNE can use to assess their transfer pricing policies and their implementation and documentation capabilities. Assessing your transfer pricing environment We recommend MNEs take the following steps to assess the robustness of their transfer pricing policies, pricing, and associated documentation and their readiness for the new compliance environment: Conduct a transfer pricing policy review Prepare a draft CBCR Perform sensitivity testing using financial analyses to identify any transactions, structural issues, or policies that may be vulnerable to scrutiny Conduct a gap analysis based on identified transfer pricing risk Address risks and assess opportunities. Transfer pricing policy review For your transfer pricing policy review you should gather information from a variety of sources, such as: tax returns; existing transfer pricing documentation; questionnaires and information gathered from staff in each jurisdiction; management reports; tax and transfer pricing audits done by companies within the group; and any other relevant information. The tax positions taken in the financial statements should also be considered. Information from outside sources may also be relevant, such as: patent information concerning intellectual property rights; securities analyst reports; commercial databases; press reports; and any other publicly available information. In reviewing this information, assess and evaluate the appropriateness of the existing transfer pricing policy. Consider how the various tax authorities may view this information when considered in conjunction with the information presented in the CBCR. Prepare a draft CBCR Once you have all the relevant information, prepare a draft CBCR. Actually filling in the columns in the OECD template will help focus attention on the information needed regarding the MNE and Constituent Entities. Preparing the draft will help you assess the reporting systems and processes used, as well as the robustness of the transfer pricing policy. 2

4 Take action now Assess potential risks There are five broad types of transfer pricing risks to assess: Transaction related risks These can be related to transaction volumes or values. They can also relate to transactions for which no payments were exchanged. Based on best practices, consider what pricing methodologies should be used when evaluating transactions and related risks. Profit related risks These can arise, for example, if there are sustained losses or decreasing margins. Evaluating these risks involves comparing group profit margins, conducting comparables testing, and comparing profits to other metrics (for example, the number of employees). A CBCR can be the starting point for this analysis. Geographic risks These can arise, for example, in jurisdictions where the tax authorities are known to aggressively pursue transfer pricing; when the entity has transactions with a related entity in a tax haven; or when non-oecd methodologies are used. When evaluating these risks, consider things like local headline tax rates and effective local tax rates. Structural risks These can arise, for example, when special purpose vehicles are used; when hybrid entities are included in the corporate structure; or when one-off transactions occur. When evaluating these risks, check for consistent treatment across jurisdictions. Process related risks These can arise, for example, when persons responsible for implementing the policy are ineffective, or when there is uncertainty as to who is responsible, whether at the head office or at Constituent Entities. It can also arise if current documentation is not prepared. When evaluating these risks, review process controls, as well as standard operating procedures (SOPs), and the terms of advance pricing agreements (APAs). Conduct a gap analysis Once you have identified potential vulnerabilities, it s important to analyse gaps between the actual situation and the optimal situation, as well as what position the MNE considers acceptable. Consider quantitative outputs, such as the amount of tax at stake. Also consider qualitative outputs, like complexity and subjectivity of positions, and how supportable the enterprise s position is. Also consider the transfer pricing case law and doctrine in jurisdictions prone to controversy and litigation. Assess opportunities Review of the CBCR may also reveal planning and optimizing opportunities. One such example would involve reducing profits earned in jurisdictions where the profits reported in the CBCR are in excess of the profits expected under the MNE s existing transfer pricing policies. The draft CBCR and your analysis of it will also help you articulate a clear strategy and approach, which should help increase stakeholders awareness, buy-in, and support for the enterprise s transfer pricing policy. This, in turn, should help ensure you apply a consistent approach to all the transfer pricing documentation (the Master File, Local File(s), and CBCR). 3

5 How BDO transfer pricing specialists can help you Though MNEs have a lot to do to in preparation of filing their first CBCR, we believe that as they go through the steps needed to prepare their filing, they should recognize this as an opportunity to ensure they have a robust transfer pricing policy in place. We have developed a methodology that allows us to create a profile of the status of your enterprise s transfer pricing mechanisms and policies. As part of our service, we assess and can help you minimize risks you face with the new documentation and reporting requirements. The process begins with a review of specific information you provide us, such as tax returns; financial statements; human resource information, such as headcount; and written transfer pricing policies and procedures. We then meet with you to review the BEPS requirements and their possible impact on your organization. We discuss your transfer pricing policies and the methods your organization uses to ensure arm s length pricing on intercompany transactions. Our transfer pricing experts work with you to ensure that you are employing best practices in your transfer pricing policies and methodologies. We also provide you with an overview of the allocation of income, taxes, and business activities by tax jurisdiction. This overview provides you with indicators of where you stand and whether you have particular risks. Early assessment of your specific situation means you have more time to address any risks or weaknesses that may exist and to make the most of potential planning and optimization opportunities. Your stakeholders will appreciate the clarity and transparency and you will be well prepared to fulfill your OECD BEPS reporting requirements. Conclusion Enterprises should take action now to understand, address, and manage their reporting process so there are no surprises. Though doing so might be burdensome, MNEs that develop robust systems to fulfil the documentation requirements could end up saving money by taking advantage of planning opportunities that come to light in the process of complying. As well, enterprises should keep in mind that money and effort spent complying with the OECD s guidance will likely pay off in the event of a transfer pricing dispute. 4

6 CONTACT If you would like to discuss any aspect of this bulletin in more detail, or any other transfer pricing issue, please contact your usual BDO adviser. This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained herein without obtaining specific professional advice. Please contact the appropriate BDO Member Firm to discuss these matters in the context of your particular circumstances. Neither the BDO network, nor the BDO Member Firms or their partners, employees or agents accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it. BDO is an international network of public accounting firms, the BDO Member Firms, which perform professional services under the name of BDO. Each BDO Member Firm is a member of BDO International Limited, a UK company limited by guarantee that is the governing entity of the international BDO network. Service provision within the BDO network is coordinated by Brussels Worldwide Services BVBA, a limited liability company incorporated in Belgium with its statutory seat in Brussels. Each of BDO International Limited, Brussels Worldwide Services BVBA and the member firms of the BDO network is a separate legal entity and has no liability for another such entity s acts or omissions. Nothing in the arrangements or rules of the BDO network shall constitute or imply an agency relationship or a partnership between BDO International Limited, Brussels Worldwide Services BVBA and/or the member firms of the BDO network. BDO is the brand name for the BDO network and for each of the BDO Member Firms. Brussels Worldwide Services BVBA, February 2015