There is more to BEPS than meets the eye
Much lies beneath the surface of BEPS. How will BEPS affect Korean multinationals and what do MNEs need to learn? Tae Hyung Kim, partner and senior transfer pricing economist at Deloitte Korea, explains exactly what multinationals must consider and what they should fear.
The Korean National Tax Service (NTS) and the Ministry of Strategy and Finance are gearing up for what's ahead with BEPS. They are moving slowly but surely.
The ministry provides the specific guidance for master files and local files. The details are stipulated in the Law for Coordination of International Tax Affairs (LCITA) as Enforcement Decree (ED). The guidance specifies who should submit what and when. In essence, what is stipulated in the ED is literally the same as the Korean translation of OECD Action 13 Annexes I and II. The LCITA-ED provides Korean templates for the master file (MF) and local file (LF). In both templates, the ED itemises each information category and all specific items under each category in Annexes I and II in Korean. Country-by-country reporting requirements will be put in place certainly, not in fiscal 2016 but in fiscal 2017. That's all that is planned so far for this year.
On the tax administration side, the NTS is moving rather quickly on the resource side. The NTS acknowledges that sufficient resources are necessary to perform risk assessments with the files and the information contained in the files. The NTS plan to pool the right resources and train them to perform risk assessments. Most of all, the author would like to see the NTS bring in economics professionals to provide the necessary training to the NTS examiners. The NTS has not recruited nor employed an economist since the inception of the LCITA in 1996, as far as the author is aware.
Overall, the NTS and the ministry have been reactive in paying attention and responding to base erosion and profit shifting (BEPS). They have followed developments at the OECD and monitored developments and news in other jurisdictions around the globe, but until recently there has not been much discussion between the government (both the NTS and the ministry) and taxpayers. The practitioners have been rather active in comparison, holding public seminars to discuss and disseminate the OECD final deliverables on actions.
In this article, the author intends to focus on what is below the surface of BEPS. What does BEPS really mean to Korean MNEs? What do Korean MNEs in particular need to think about? Why should the top management care about BEPS? What's next?
BEPS is a whole new ball game
There is little doubt that the tax authorities will have the upper hand with important data and information at their fingertips. It was a different story in the past. Under the new rules, the information required in the master file (MF), local file (LF), and country-by-country reports (CbCR) will cover almost every aspect of an MNE's business: global value chains and key profit drivers, a list of all intangibles, the way the group is financed, transfer pricing policies for major products, services, intangibles, and financial arrangements, ties between the financial data used in transfer pricing methods and the MNE's financial statements, and so on. The list goes on. The tax authorities can request even more focused details on the information already supplied to the extent that it is needed.
A few points are worth mentioning here. The objectives are clear with transfer pricing documentation in Action 13. What they really mean to MNEs is less clear. The focused and specific information required under the MF and LF will be handed over to the tax authorities before an audit. And the exact same information will be available to all relevant tax authorities at the same time.
The author would like to emphasise that a great deal of focused and specific information will be in the hands of tax authorities. What is clearly different with BEPS is that the time frame for handing over all of this information to the tax authorities will be before an audit. The availability of the information to the tax authorities changes who's calling the shots in the ball game. Even before the ball game begins, information will be fully analysed to assess risks for the audit. MNEs should not miss the fact that tax authorities will have plenty of time. Not a few weeks or months but even a few years to the extent that the statute of limitation allows. Put simply, it is enough time. Not to mention fast-changing data analytics technology available everywhere. The information can be sliced, diced, and drilled down on to the very bottom of the issue quickly. This is new under the sun. Tax authorities will try to put all available resources to full use before they pin down the objects. In addition, MNEs should always remember that the exact same information will be available to virtually all relevant tax authorities at the same time. How will the tax authorities in different jurisdictions respond? What can MNEs do about it?
Prepare for unilateral actions
MNEs may wish that they had a crystal ball. It will not be easy to predict the future. The author's view is that the exact same information is more likely to be interpreted differently by different tax authorities across continents. The differences could be a result of various factors: different kinds of priorities and interests, different ways of approaching issues and resolving matters, different educational backgrounds, different levels of experiences, different levels of understanding of the information, and so on. As a result, they could view and respond differently. All this could contribute to unilateral actions by each tax authority. The author expects a significant number of lengthy battles between tax authorities and MNEs and also among competent authorities. In particular, MNEs should keep this point in mind and take it into consideration when they engage in disputes with the tax authorities.
Consistency should top the priority list
Inconsistency matters. MNEs need to pay particular attention to transfer pricing methods and polices over the past years. Of course, this is the case to the extent that the years fall within the statute of limitation. The information contained in the MF, LF, and CbCR can be analysed to assess risks in the past years. If proper documentation is not in place for the past years, the information provided in the MF, LF, and CbCR for the fiscal year 2016 could provide benchmark information for those years. The MNEs should expect that the tax authorities, and in particular the NTS, can always confront the MNEs with any inconsistency that exists between the past years and the present year. It is worth double checking whether proper transfer pricing policies were coordinated centrally by the headquarters of the MNEs in the past.
Tax authorities lack and need proper training in economics
A great deal of important information will be at the NTS's fingertips. The NTS will slice and dice the information to make risk assessments and to determine whether an audit is necessary. The author expects that tax authorities will continue to make investments in human resources. The resources will be put in place to educate and train tax examiners and get them ready before the rubber hits the road. The author doubts, however, that the NTS will bring in economics professionals to train them. That's what might worry MNEs. Most of the NTS examiners do not have the appropriate level of capabilities needed in performing economic analysis. The NTS does not have economists and lacks training in economics and therefore relevant skills. Value creation and profit allocation is all about economics from the start and also at the end of the day. Until the tax authorities are equipped with the right analytical capabilities, it will pay off if the MNEs are ready to go the extra miles to educate the tax authorities.
MNEs need to reset the mindset
MNEs vary in terms of the depth and breadth of experience, understanding, and skills they have in BEPS-related issues and matters. In other words, there are MNEs that fully understand how BEPS will change the landscape of the global playground and know what to do about it. There are MNEs that do not have any idea about what it really means to them at all. Advice and recommendations about what the MNEs need to do should vary accordingly as well.
When cost concerns come first, it is hard to manage transfer pricing policies. Getting the job done properly is a challenge. For example, to most Korean MNEs, and also for many other non-Korean MNEs, minimising compliance costs tops the priority list most of time. That mindset is more likely to result in poorly prepared, low quality documentation. To them, BEPS means just another cost or more costs. The author's view is that they fail to see the woods for the trees. As a result, they don't have a serious game plan.
The number one challenge, therefore, is to change the mindset. Top management at the headquarters of MNEs must understand BEPS in great detail and what it means to them. They must know what MNEs need to do. MNEs are required to disclose a lot of information that is sensitive and confidential. For example, they need to describe the overall R&D strategy including ownership and exploitation of intangibles, location of principle R&D facilities, and location of such management and provide a list of intangibles transferred cross-border between related parties and a list of important agreements, and so on. It is not a choice. It is a must.
To the author's mind, the people at the top management of most of the Korean MNEs need a wake-up call. Tax managers and executives should make sure that the top management is fully aware of what is required in BEPS. The level of detail for the information that needs to be disclosed should be managed properly in a professional manner. For that to happen, the top management must understand the depth and breadth of the details in the information required. Based on prudent business judgment, the top management should be able to determine the appropriate level of detail for the information that needs to be disclosed. This is one of the most important processes in preparing for BEPS challenges going forward.
Action 13 emphasises that the disclosed information will be used only for tax risk assessment and audit purposes. Tax administrations in all jurisdictions will do the job to protect the confidentiality from their end. However; the level of legal protection in each jurisdiction will vary depending on local laws and enforcement efforts. It will be wise for MNEs to make every effort to ensure that that remains the case. It is prudent for MNEs to monitor such efforts being made around the globe. Again, remember that all confidential information will be accessed and analysed by virtually all relevant tax authorities at the end of the day.
Time to move with a sense of urgency
There is a prevailing perception in Korea that what MNEs are paying as taxes is not fair. Nowadays, this perception may apply to other jurisdictions as well. Whenever there is news about tax matters of MNEs, it is bad news. Bad news grabs public attention quickly. It makes a big impact but in a bad way. That is why Korean MNEs should worry about BEPS and pay attention immediately. The MNEs need to put in place a strong team capable of handling all aspects of potential risks from all angles. This requires new thinking about the people with the right skill sets with global experiences.
It is no use locking the stable door after the horse has bolted. If BEPS is not managed properly, there will be the devil to pay. Above all, it could do serious harm to brand and reputation, not to mention operations and businesses. Social networks convey news in the wink of an eye. In particular, bad news travels fast. It is a big deal.
A sense of urgency is needed. There are a few must-dos for Korean MNEs. First and foremost, top management and management executives should grasp the gravity of BEPS as soon as possible. They also need to instill the sense of urgency in employees to win their buy-in as well. Under the new rules of the international tax game, noncompliance penalties, additional taxes, reputational risks, and loss of value-enhancing, tax-saving opportunities won't come in a small package. Being wise after the fact is not wise after all.
Tae Hyung Kim
Partner & Economist
Deloitte Anjin LLC
Tel: +82 2 6676 2410
Tae Hyung Kim is a senior partner and an economist at Deloitte Korea. Kim has represented and advised multinational corporations in various industries on their global transfer pricing and supply chain management strategies for more than 19 years. In doing so, he has handled and resolved complex transfer pricing disputes and negotiations with both Korean and foreign tax authorities.
Kim has been recognised as a world leading transfer pricing adviser by Euromoney's Legal Media Group and also as a leader in tax controversy in Korea by International Tax Review. As a country panellist, he has been a regular contributor to BNA Bloomberg's international transfer pricing forum.
He holds a Ph.D. in economics from the University of Washington and is also a graduate of the advanced management programme of Harvard Business School. He graduated from Korea University with BA in economics.