On October 3 2013 the OECD released a memorandum on transfer pricing documentation and country by country reporting (further referred to as OECD memorandum) as a result of the base erosion profit shifting (further referred to as BEPS) action plan issued on July 19 2013.
The memorandum further develops action 13 of the BEPS action plan, which is aimed at further advancing the rules regarding transfer pricing documentations to enhance overall transparency for the tax authorities. A common country by country reporting approach is the focal point of the OECD memorandum, which has been used as a guiding outline for the November OECD Working Party 6 (further referred to as WP6) discussions in Paris.
Breakdown of memorandum on transfer pricing documentation and country by country reporting
The guiding principle of the OECD memorandum is that the common reporting requirements template should take into account the usefulness of the data actually presented to the tax authorities but also the compliance burdens placed on the taxpayer. In essence the goal of the OECD in developing a standard reporting template is not to unnecessarily increase the compliance burden but rather to increase transparency and overall taxpayer operational efficiency. The OECD memorandum poses two fundamental questions: what information should be required? and what mechanisms should be developed for reporting and sharing country-by-country data?.
In terms of what information should be required, the OECD has taken the approach that data, which is readily available to the corporate management, should be a starting point for building the common template. The types of data available to corporate management across jurisdictions may be different based on respective accounting standards and management accounting systems. Nevertheless, the intention is to step away from the need for taxpayers to have to construct new data specifically for tax reporting purposes.
Reporting of income
The most important reporting item that should be present in the country by country reporting template is income. The OECD memorandum introduces several income data reporting approaches and summarises the pros and cons of each.
The first income reporting approach focuses on the reporting of net income before tax for each legal entity operating within the confines of the multinational enterprise (MNE). The actual income data should be drawn from the individual entity statutory financial statements. It has also been further suggested that the information from the legal entities could be grouped by country of organisation or place of management, thereby making it significantly easier to aggregate data on income. Some of the drawbacks to this approach include the fact that the grouping of legal entities, by place of organisation or location of management, would not necessarily indicate where the income of these entities is coming from or whether they are subject to tax in that location. Resident and non-resident companies for tax purposes may be subject to different tax regimes in the same country. Two additional drawbacks of this income reporting approach are that not all countries require statutory reporting for every MNE company operating in that country and also, for consolidation reasons, the sum of the statutory financials of each legal entity in the MNE may not necessarily be equal to the income reported on the MNE level.
Another approach is that the income reported in the standard reporting template could be based on the taxable income reflected in the tax returns filed within the respective operational jurisdictions of the MNE. From a business perspective the tax related financial information should be readily available to the MNE thereby significantly reducing the compliance burden. A similar drawback, as mentioned under the first income approach, is that depending on the country of operation the MNE may not necessarily file a tax return or report all of its income. Similarly the definition of deductible versus non-deductible expenses would have an impact on the overall taxable income being reported. Income and cost definition differences for tax purposes across jurisdictions would lead to additional explanations being necessary when the MNE would not be able to reconcile its group level taxable income with the income stated in the local tax returns.
A third possibility, as suggested by the OECD memorandum, would be to report income on the basis of a segregated statement of the consolidated MNE income, which would be presented on a country by country basis. This top down approach would potentially eliminate consolidation discrepancies but would also require the production of data which MNEs may not necessarily keep in the normal course of operations. Furthermore the segmentation of the data would also require information on the individual country income source, as well as cost type, that may not necessarily be part of the country’s regular local tax or accounting reporting policy.
A fourth notion would be to take advantage of internal income statements used for the consolidation of the overall MNE income. This approach would allow for the differentiation of each local company’s income contribution to the overall MNE income. The potential drawback would be whether this information would be readily available and whether it would contain information regarding income generated as a result of intercompany transactions.
The aforementioned approaches are meant to guide the overall country by country reporting discussion and have been used as the fundamentals of the WP 6 discussions in November 2013.
Reporting of tax paid in the countries of operation
Another important country by country reporting element is taxes paid by country. This indicator would allow for the tax authorities to have a clearer understanding of the MNE’s business and international tax footprint. The OECD memorandum considers several technical aspects of the taxes paid data element of the country by country reporting approach.
The first fundamental issue is whether the reported country by country tax information should be disclosed on an accrual or cash basis. Due to the difference in the timely recognition of both, the OECD memorandum does not have a firm standing on the means by which the tax reporting needs to be carried out.
Another question raised by the OECD is whether only national level income taxes should be reported. Depending on the jurisdiction a local requirement may impose the need to also report sub-national tax payments. To avoid increasing complexity it may be necessary to segregate both tax levels for more transparent reporting purposes.
A third open point is whether any other types of taxes, other than income taxes, should be reported. From a purely transfer pricing perspective, property taxes, personal income tax or VAT do not necessarily have a positive impact on overall reporting from a tax authority perspective. It could potentially be argued that adding this level of detail would only unnecessarily increase the burden on the taxpayer without providing much, if any, additional insight for the tax authorities.
Reporting of additional measures of economic activity
The OECD memorandum has also investigated whether any additional information, outside of income and tax paid, is necessary to indicate economic activity for transfer pricing reporting purposes. The decision as to which additional items will be reported on a legal entity level or per country basis are up to WP 6, nevertheless the supplementary information will make it possible for tax authorities to track whether there is a difference between the location of the economic activity and the place where the income is actually being reported. Some of the additional measures of economic activity include the following:
1. Revenues by location of customers – though this information may not be readily available, it seems that the overall goal of the OECD is to track why revenues in a given country of operation are high but the consequent taxes paid are not.
2. Tangible assets by location – it may be presumed that similar to point 1) the location of the tangible assets would also be representative of the revenue in that location (tangible assets used for production etcetera).
3. Employment information either by number of employees or total payroll – this information would also allow the tax authorities to make comparisons between the location of key personnel and the consequent income and tax paid.
4. Research expenditures by company/country - it may be inferred that consequently the intellectual property as a result of the research expenditures will also be attached to that company/country.
5. Marketing expenditures by company/country – similarly to the statement above these expenditures may lead to the development of a local intellectual property, such as brand or trademark, which should attract a certain level of income.
6. Location of intangibles by country – could potentially be determined from the country by country balance sheets and used to monitor income allocation within the MNE.
7. Location of senior management – could be used to track where tax is being paid.
The OECD memorandum, in addition to the points mentioned above, has also considered whether the reporting needs to be conducted in a single currency, whether income information on royalties or interest paid could also be readily available for a greater degree of taxpayer transparency.
Completion of standard reporting template by parent company
One potential option would be for the parent company to complete the template in its place of management or incorporation and then share it with countries where its affiliated entities operate. Ultimately the success of this option would rely on local law and the willingness for the MNE headquarter host countries to enforce the preparation of such a template.
It is also quite important that if the initial option suggested above is implemented, the exchanges between the countries would take place under strict confidentiality to ensure that the competitive advantage of the reporting companies remains unaffected.
Global masterfile documentation integration
Another tool that could make it easier for MNEs to use the reporting template would be to make it an obligatory part of their global masteriles. Consequently the countries in which the affiliated entities of the MNEs operate could make it obligatory for the legal entities operating in their tax jurisdictions to deliver the template for local tax authority analysis.
Outtakes from WP 6 November meeting
Representatives of government and business met on November 12 and 13 to discuss the OECD memorandum and the overall reporting approach suggested in the document.
The overall business comments were that the information provided in the standard template should be: readily available, brief, possess a materiality threshold, standardised and flexible depending on the types of information available to the MNEs. In addition business representatives suggested that the template should be provided to the MNEs in the tax jurisdiction of their headquarters and that the information should be kept confidential as well as shared with other jurisdictions only for the purposes of an initial transfer pricing indication and not a detail tax analysis.
WP 6 will continue working on the country by country reporting approach until September 2014 when the OECD will introduce the country by country key reporting metrics to the international business and tax community.
Impact of country by country reporting on German documentation requirements
The regulation as to the nature, content and scope of documentation under Article 90.3 of the German Tax Procedure Law issued by the German Ministry of Finance in 2003 sets out the requirements for the German transfer pricing documentation.
Article 4 of the aforementioned regulation does already require some of the information described in the OECD memorandum, such as a list of intangible goods which the taxpayer owns and uses (Article 4.2b). It is also often the case that some of the information requested in the OECD memorandum is provided as a result of a tax audit inquiry.
Nevertheless the level and extent of detailed information presently under discussion by the OECD would require modifications to the current German legislation.
Germany having some of the most comprehensive transfer pricing tax law and a track record of following OECD guidelines is likely to institutionalise the potential country by country reporting requirements.
It is important to note, however, that the guiding principles of the OECD memorandum, in that the common reporting requirements template should take into account the usefulness of the data actually presented to the tax authorities but also the compliance burdens placed on the taxpayer, should not be ignored. The ultimate success of increasing the levels of business tax transperancy will depend on the tax authorities and the taxpayers finding a balance between compliance as well as operational efficiency.
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